FOREX-Dollar on the defensive as Fed outcome looms

SYDNEY/TOKYO Tue Apr 30, 2013 10:37pm EDT

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SYDNEY/TOKYO May 1 (Reuters) - The dollar languished near a two-month low against a basket of currencies on Wednesday as investors wagered the U.S. central bank will recommit to its aggressive stimulus programme, or even possibly expand it.

The dollar index was at 81.726 , after having fallen to a low of 81.598 on Tuesday. The break below 81.744, the 38.2 percent retracement of its January-April rally, has opened the way to 81.204, the 50 percent retracement level.

Dollar bears shrugged off a rise in U.S. home prices and a rebound in U.S. consumer confidence, focusing instead on an unexpected contraction in Midwest business activity.

This data came as Federal Reserve policymakers gathered for their monthly two-day meeting amid talk the central bank might have to add more stimulus to help broaden a still-patchy economic recovery.

"We see the risks as titled on the dovish side as the Fed is now effectively falling short on both its employment and inflation objectives," said Vassili Serebriakov, strategist at BNP Paribas.

"We expect this week's meeting to support our view that no QE3 tapering is likely until year-end and that the risk is for more, not less, easing."

That is a sea change from just about a month ago, when most market players believed the Fed's next move would be to scale back easing, rather than, doing more of it.

The dollar drifted lower on the yen to 97.32, about 0.1 percent below the late U.S. levels after having hit two-week low of 96.99 yen the previous day.

Although the yen had been under intense pressure thanks to the Bank of Japan's own radical stimulus programme, yen bears were abandoning their bets for now as the currency has a strong support at the big number of 100 due to buying from Japanese exporters and option players.

"At the moment, the market is considering the 97-100 yen range. But if upcoming U.S. economic data continues to disappoint, there's risk the dollar/yen's trading range will ratchet down to say 95-98," said Yoshio Takahashi, analyst at Barclays Capital in Tokyo.

Among others, many traders are looking to the manufacturing index from the Institute of Supply Management at 1400 GMT and Friday's employment report.

The greenback lost ground against the euro, which climbed to a two-week high near $1.3187 on Tuesday and last stood at $1.3166, flat from late New York levels. The common currency now faces tough resistance around $1.3200, a level that capped it last month.

The currency took Moody's credit downgrading of Slovenia to junk status in its stride.

The euro's strength has surprised markets because euro zone data has been as disappointing as the U.S. indicators. The euro's strength added to pressure for a cut in interest rates by the European Central Bank on Thursday.

But some analysts said that while a rate cut could see the euro initially fall, announcing further easing measures would be interpreted as a positive move by the central bank and this could lend the euro support.

The Australian dollar stayed near a two-week high of $1.0386 hit on Tuesday. It stood little changed at $1.0371, unable to extend gains after China's official purchasing managers' index (PMI) falling slightly despite economists' forecast of a small uptick, although it stayed in expansion territory.

The Aussie appeared to be gearing up for another go at stiff resistance seen near $1.0400, an area containing several key chart levels including the 50 percent retracement of its April 11-23 decline.

Trade was subdued in Asia with many markets, including Singapore and Hong Kong, on holiday for May Day and is likely to remain so in Europe, where several markets will be closed as well.

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