THE DOLLAR retreated on Monday in Tokyo on profit-taking after the euro failed to fall below a key support level around $1.2360. The dollar?s reversal came after a staunch two-day rally which erupted on Wednesday after the Federal Reserve surprised the market by dropping the phrase ?considerable period? when referring at how long interest rates will remain at current decade-low levels. Financial markets interpreted that shift in language as a signal that the Fed was nearer a rate hike than was expected, boosting the greenback. Official US interest rates remain at 1 percent, their lowest since 1958, and this had put the dollar at a yield disadvantage vis-a-vis higher-yielding currencies such as the Aussie, euro and sterling.

Stock and bond prices, which had been up prior to the Fed announcement, fell sharply. Bonds fell about a point on the headline. The market was caught positioned the wrong way and the knee-jerk reaction was that the Fed was moving up the timing of a rate hike.

Ten-year treasuries and June Fed Funds futures rallied, suggesting a rate hike likelihood during H1. The market is thus reassessing its views on the timing of a rate hike, though the Fed noted that with inflation quite low and resource use slack, the Fed could be patient in removing its policy accommodation. Against the Mauritian rupee, the common currency was trading at MUR 32.50 as compared with MUR 32.76 a week earlier.

The yen ticked up on Monday, flirting around three-year highs against the dollar, as speculation grew that the Group of Seven (G7) industrial nations may not agree on halting the dollar broad-based decline when they meet on Friday and Saturday in Florida. However, traders remained cautious over possible intervention after the dollar spiked up a full yen to 106.65 yen on Wednesday.

?Smoothing volatility?

Ministry of Finance data showed Japan intervened in record amounts of about $67.56 billion in January in an attempt to protect an export-based recovery of the economy. Earlier during the week, the yen got a boost after Finance Minister Tanigaki said Japan?s intervention policy was aimed at smoothing volatility, not at maintaining the yen at a specific level. Market players interpreted the comments as a sign that Japan may refrain from intervening aggressively lest facing criticisms alongside the key G7 meeting.

At last September?s G7 meeting in Dubai, Japan held off from conducting any intervention immediately before and after the meeting, despite the dollar dropping after the conference to around 111 yen from 115 yen. Yesterday, the Japanese currency was offered at MUR 24.86 as compared to MUR 24.83 on last Tuesday.

Sterling dipped slightly on Monday in London after surprisingly weak consumer credit data cooled off speculation of an imminent rate hike. Bank of England data showed consumer borrowing rose at its slowest pace in nearly seven years in December, a month after the Bank began its tightening cycle by raising 25 basis points.

Nevertheless, recent market polls showed most economists expect the Bank to hike rate sooner than later in Q1, especially after upbeat readings in UK growth and manufacturing data last week.

Earlier, the pound heaved a sigh of relief after Premier Tony Blair staved off a two-headed hydra. Blair survived a party rebellion in parliament on Tuesday after the narrow voting of his educational bill, whilst Lord Hutton exonerated him of all charges in the enquiry into the circumstances leading to the death of a UK weapons expert last year. Yesterday, the pound was trading at MUR 47.76 as against MUR 47.72 on last Tuesday.

Major data/events this week:

Wed 4 February : EZ Reuters Services PMI, GB Reuters Services PMI, US durable goods, US ISM non-manufacturing

Thu 5 February : EZ retail sales, Ger unemployment rate, Ger industrial orders, ECB rate, BoE rate, US jobless claims

Fri 6 February : US unemployment

Mon 9 February : GB manufacturing and industrial production, GB PPI output

Tue 10 February : GB trade balance

Contribution by HSBC