Dollar Drops on Low Inflation Data
Policy + Politics

Dollar Drops on Low Inflation Data

The dollar slumped broadly on Friday, halting a rally that had taken it to an 11-month high against the yen and a one-month peak versus the euro as tame U.S. inflation data prompted investors to rethink expectations of higher interest rates.

A rise in Treasury bond yields after recent strong economic data reflected investors betting that the Federal Reserve may be more aggressive and tighten monetary policy sooner than anticipated, or at least push further stimulus off the table. Those higher rates boosted the dollar's allure earlier in the week, but a sharp sell-off ensued on Friday after a report showed little sign that underlying U.S. inflation pressures were building up. The dollar was last down 0.2 percent at 83.34 yen, though not far from an 11-month peak touched on Thursday as the yen continued to struggle in the wake of surprise monetary easing in Japan last month.

George Davis, chief technical analyst at RBC Capital Markets in Toronto, said USD/JPY remains on an uptrend while prices trade above an ascending channel base at 82.05. "With initial support located at 82.73, prices will have to register a daily close above resistance at 83.81 in order to sustain the uptrend," he said. "This outcome would then shift the focus up to 84.62 and 85.53." A daily close below 82.05 will be required in order to spark a corrective phase for USD/JPY, he said.

The dollar has gained around 8 percent against the yen so far this year as the spread between the two-year U.S. Treasury yield and its Japanese counterpart remain elevated at levels not seen since mid-2011, Reuters data showed. Still, despite Friday's price action, the dollar has gained 1.1 percent against the yen this week, its sixth straight weekly advance. The euro was last up 0.4 percent on the week against the dollar, snapping two weeks of declines at current prices.

Other reports Friday on U.S. industrial output and consumer sentiment only added to negative sentiment around the dollar. The euro was last up 0.7 percent at $1.3174. RBC's Davis said EUR/USD tested, but held above key double bottom support at $1.3028 this week and a daily close above resistance at $1.3120 would generate a bullish short-term trend reversal for the pair.

"With the daily studies at oversold levels, the trend reversal would favor a corrective bounce toward secondary resistance levels at $1.3289 and $1.3485, the recent high," he said. "A daily close below $1.3028 would be required to nullify the corrective potential that is present, exposing $1.2877 thereafter."

Commodity-linked currencies came off their recent lows against the dollar, with the Australian dollar up 0.6 percent at $1.0586, comfortably above the two-month low plumbed on Thursday.

The Australian and New Zealand dollars hovered near multi-month highs against the yen as investors searching for higher yield switched from dollar-funded carry trades to yen-funded ones. In carry trades, investors borrow cheaply in lower-yielding currencies, which they then sell to buy higher-yielding units.

Both the Australian and the New Zealand dollars carry the highest interest rates in the industrialized world. The Antipodean pair have been notching solid gains against a sagging yen after the Bank of Japan eased policy last month. The Aussie has risen 12 percent this year, while the kiwi has soared more than 14.7 percent since January 1.

"As long as the yen remains under pressure, investors looking at yield differentials will continue to pile on to the Aussie/yen," said Stuart Frost, head of Absolute Returns and Currency at fund managers RWC Capital in London. "These yen-funded carry trades can continue for some time with our near-term target for Aussie/yen being 90 yen." The pair was trading at 88.13 yen, having hit its highest level since early May, 2011.

The New Zealand dollar was up 0.3 percent at 68.63 yen, at one point rising to its highest since May 2010.

Additional reporting by Nick Olivari