China Burnishes Euro Appeal as Dollar Falls With U.S. Rate View

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China’s surprise devaluation is proving a boon for the euro.

The 19-nation currency advanced versus most of its major peers for a second day as investors fleeing China-exposed markets unwound bets against it. The euro overtook the dollar Wednesday as the refuge of choice on concern Chinese policy imperils the timing and path of rate increases from the Federal Reserve.

“As risk is coming off, the euro’s going up” with traders unwinding carry trades, a strategy that sells one currency to buy another with a higher interest rate, said Ian Gordon, a foreign-exchange strategist at Bank of America Corp. in New York. “It’s not changing our view that the Fed could hike in September. It only raises the risk they won’t a little bit.”

The euro rose 1.1 percent to $1.1159 as of 5 p.m. in New York, touching a one-month high of $1.1214. The shared currency added 0.3 percent to 138.60 yen. The Bloomberg Dollar Spot Index, which tracks the greenback versus 10 major peers, slumped 0.8 percent to 1,203.85.

Yields Converge

It wasn’t so long ago that the euro seemed destined to fall to parity versus the U.S. currency within weeks.

Unprecedented stimulus from the European Central Bank spurred an exodus of capital from the currency bloc as investors looked elsewhere for yield. Policy makers’ commitment to bond buying through September 2016 has started helping the currency as traders bet the ECB will push on, while other central banks may look to ease further.

The euro climbed to a seven-month high among a basket of 10 developed-market peers as the gap between the yields on German bunds -- the euro area’s benchmark bond -- and Treasuries narrowed to the tightest since June.

“You’re seeing a short squeeze in the euro, and a bit of safe haven,” said Collin Crownover, State Street Global Advisors Inc.’s Boston-based head of currency management. China’s move “rightly reduces the probability of the Fed going in September, although I don’t think it reduces it as much as what the market is pricing in.” A short squeeze is when traders betting on a weaker currency are forced to offset those positions at higher prices.

China Move

China’s central bank cut its daily reference rate for the yuan by 1.6 percent on Wednesday, after reducing it by a record 1.9 percent on Tuesday. That’s clouded the outlook for the first U.S. rate increase since 2006 by highlighting weaknesses in the global recovery and the risk of a prolonged slowdown in commodity prices that undercuts inflation.

Fed Bank of New York President William C. Dudley said he would watch the ramifications of China’s move “very closely,” while noting that any weakening of the yuan to match China’s slower growth is understandable.

Traders are pricing in a 44 percent probability that the Fed raises rates at the September meeting, compared with 54 percent on Aug. 7, based on the assumption that the effective fed funds rate will average 0.375 percent after liftoff.

“There’s been a flight to safety,” Myles Clouston, a New York-based senior director at Nasdaq Advisory Services said by phone. “There is an expectation that the prospects for a rate hike may be put back.”

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