Dollar dips as Fed to buy long-dated Treasuries

NEW YORK Tue Aug 10, 2010 4:54pm EDT

NEW YORK (Reuters) - The dollar fell against the yen on Tuesday after the Federal Reserve announced plans to boost a flagging economy by reinvesting money from maturing mortgage bonds in government debt.

The central bank acknowledged economic growth had slowed in recent months and reiterated its intention to hold benchmark interest rates at record lows for an extended time.

The move marked a policy shift for the Fed, which only a few months ago debated how to start winding down some of its monetary stimulus programs.

Worries about U.S. recovery pressured the dollar. So too did prospects of lower U.S. rates which prompt Japanese funds heavily invested in dollar-denominated Treasuries to repatriate profits, benefiting the yen.

Treasury prices rallied, led by longer-dated notes, pushing down yields and undermining the dollar's appeal to investors. The currency fell as low as 85.19 yen, near a 15-year trough.

The euro briefly rose above $1.32, well off the day's low but was still slightly weaker against the dollar on the day as

investors continued to book profits following last week's gains in the single currency.

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The Fed's move and its downgrade to the economic outlook "is a problem for the dollar in general," said Brian Dolan, chief strategist at Forex.com in Bedminster, New Jersey.

The greenback has struggled mightily over the last month, battered by signs of weaker U.S. growth and speculation the Fed would move to boost stimulus for a flagging economy.

However, strategists also noted the Fed's plans to reinvest mortgage bond proceeds into long-dated Treasuries stops well short of more aggressive, outright purchases of government or mortgage debt.

"We got credit easing as opposed to quantitative easing," said Sebastien Galy, strategist BNP Paribas in New York, who noted the policy shift doesn't expand the Fed's balance sheet.

Earlier this year, the Fed wrapped up a more aggressive asset-buying program with which it bought $300 billion in Treasuries and nearly $1.3 trillion in mortgage-linked debt.

"The bond market had priced in expectations that they might re-initiate asset buying and they did not do that," Dolan said. "So ultimately, I expect to see U.S. rates move higher from here and that would see the dollar come bouncing back."

The dollar fell 0.7 percent at 85.33 yen, near a 15-year low around 84.81 yen. The euro was last at $1.3181, down 0.4 percent. It fell as low as $1.3075 earlier but jumped to $1.3234 shortly after the Fed's announcement. Sterling fell 0.3 percent to $1.5848.

The dollar got support against the yen earlier after the Bank of Japan held off on new steps to weaken the strong currency.

John Doyle, a strategist at Tempus Consulting in Washington, said the euro still looks caught in a fairly tight $1.30-$1.32 range, with moves above $1.32 hard to sustain.

While the Fed's move is a modest one that will have little impact on the money supply, it does suggest officials are worried about the economy, said Vassili Serebriakov, strategist at Wells Fargo in New York.

"I would still describe this as a dovish statement and a dovish move," he said. "For the dollar, it all boils down to how long this soft patch persists."

Against a basket of six major currencies, the dollar clawed its way back above its 200-day moving average of 80.835 .DXY, though it remained more than 6 percent weaker since the start of July.

(Additional reporting by Wanfeng Zhou and Vivianne Rodrigues; Editing by James Dalgleish and Andrew Hay)

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