Dovish Fed to Damp Dollar in Surprise to Market, BNY Says

The dollar will reverse recent gains versus the euro and the yen in coming months as the Federal Reserve pares monetary stimulus at a slower pace than the market expects, Bank of New York Mellon Corp. said.

The greenback, which touched eight-week highs this month against its two most-traded peers, will test $1.38 per euro in three months, and $1.45 over 12 months, Simon Derrick, the London-based chief currency strategist at BNY Mellon, said at a roundtable discussion in Tokyo today. The U.S. currency could weaken to as low as 93 yen within five months, he said.

“If the U.S. is to deal with its fiscal problems over the next two to three years, then it also means that there’s going to have to be a cushion of easy monetary policy,” Derrick said. “In the short term as well, I think that U.S. monetary policy is likely to remain on the far more accommodative side than perhaps people are giving it credit for this year.”

The dollar will strengthen to $1.28 per euro and 110 yen by the end of 2014, according to median analyst forecasts in compiled by Bloomberg. The U.S. currency rose 0.1 percent to $1.3387 per euro and 0.5 percent to 99.70 yen as of 4:59 p.m. in Tokyo from yesterday. It reached 99.73 yen today, the most since Sept. 13, and $1.3296 per euro on Nov. 7, the strongest level since Sept. 16.

Tapering Bets

The dollar has rallied 1.5 percent since Nov. 6 against a basket of developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes as reports showed an unexpected acceleration in U.S. economic growth and job creation.

Derrick predicts the Fed will begin tapering its $85 billion of monthly debt purchases at the central bank’s March 18-19 meeting, matching the median estimate of economists surveyed by Bloomberg on Nov. 8.

He expects policy makers to refrain from raising the federal funds rate target from near zero until “well into 2015.” Traders see 21 percent odds the Fed will increase the benchmark to 0.5 percent or more by January 2015, based on data compiled by Bloomberg from futures contracts on Nov. 11.

The euro will remain resilient, buoyed by central bank buying, even as European Central Bank President Mario Draghi hinted at further policy easing after an unexpected interest rate cut last week, according to Derrick.

“The euro still represents the largest alternative reserve currency to the dollar,” he said. “The existential risk to the euro, I think, is no longer there.”

Worst Performer

Japan’s currency has also failed to sustain declines beyond 100 per dollar this year following a 20 percent drop in the past 12 months that is the worst among major currencies.

The Bank of Japan is trying to encourage investors to shift money into riskier assets, including those overseas, by holding down interest rates with monthly purchases of more than 7 trillion yen ($70.2 billion) of government bonds. Ministry of Finance data shows that exodus of capital has yet to materialize.

“In the absence of domestic money pushing overseas, I’m cautious about looking for a massive weaking of the yen for now,” Derrick said. “If anything, I think the surprise to this market could be a sudden strengthening.”

Before it's here, it's on the Bloomberg Terminal.