Dollar edges up as Fed rate decision approaches

NEW YORK (Reuters) - The dollar edged up against the euro and yen on Tuesday after a mixed bag of economic data led dealers to trim bets against the currency ahead of this week's policy decision by the Federal Reserve.

Currency traders see the central bank reducing benchmark lending rates on Wednesday, though strong readings of consumer confidence and durable goods orders moved rate futures to reflect a lower chance of an aggressive rate cut.

The Fed unexpectedly slashed rates by 75 basis points last week as global stock markets swooned and fears grew that the U.S. economy was headed for recession.

But most of the economic data on Tuesday helped clear some of the gloom. Another report showed more trouble in the U.S. housing sector but that familiar story was absorbed easily by the market.

"This is not the kind of data recessions are made of and highlights how important employment is going to be in determining whether the economy can sneak by with a growth recession (growth where unemployment rises) or something much less benign," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.

The market initially punished the dollar after last week's surprise Fed move brought benchmark lending rates to 3.5 percent.

But since then, "traders have become far more realistic, realizing the world has not come to an end and stocks have stabilized," said Kathy Lien, chief strategist at DailyFX.com in New York.

The euro slipped to $1.4770, down 0.1 percent from late Monday. Prior to Tuesday, the dollar had fallen against the euro in four out of the last five trading days

The dollar was up 0.2 percent at 107.02 yen, near a session peak of 107.23 yen hit after the durables data.

50 OR BUST?

Interest rate futures reflect a roughly three-in-five chance the Fed will cut by 50 basis points after its scheduled meeting, which would bring the federal funds rate down to 3 percent, a full percentage point below the euro zone benchmark rate and among the lowest in the industrialized world.

A lower yield would presumably make the dollar a less attractive currency in which to hold investments.

If the Fed cuts by 50 basis points, the cumulative 125 basis points of easing would be the biggest move in a two-week span since the U.S. central bank began using the fed funds rate as its primary policy tool in the early 1990s.

If such a cut is accompanied with more relatively positive U.S. economic data, investors could stampede back into the market hunting for higher-yielding, higher risk investments, said Mark Frey, head trader with Custom House, a currency services firm in Victoria, British Columbia.

"The carry trade will be back in vogue and the U.S. dollar will likely struggle, especially against the euro and the commodity currencies," Frey said.

Dealers and investors would like to see what the Fed, in the statement accompanying its policy decision, has to say about the risks ahead for economic growth -- especially with fourth quarter U.S. gross domestic product data and the January employment report due later this week.

(Additional reporting by Kevin Plumberg and Lucia Mutikani; editing by Richard Satran)