FOREX-Dollar gains ground before Fed decision; yen struggles

Wed Dec 18, 2013 7:04am EST

* Yen pressured as Japan posts 17th straight trade deficit

* Most investors still doubt Fed will taper this week

* German IFO in line with expectations

By Anirban Nag

LONDON, Dec 18 (Reuters) - The dollar gained against the yen and euro on Wednesday, helped by a rise in U.S. yields, as investors positioned for a Federal Reserve decision later in the day on whether it will start to reduce its monetary stimulus this month.

The euro shrugged off a German IFO survey that was in line with expectations. Year-end repatriation flows and higher money-market rates continued to lend it support before the Fed's decision.

Euro/dollar overnight implied volatilities -- a gauge of how sharp price swings can be -- shot up on Wednesday before a possible move by the Fed. The overnight euro implied vols more than doubled to 13.70 percent from around 5.5 percent on Tuesday.

The euro edged down to $1.3750 while the dollar rose 0.25 percent against the yen to 102.95 yen. The dollar index was marginally higher at 80.095.

"The majority in the market are expecting the Fed to hold off, but if they do go ahead and taper, then we will see a knee-jerk reaction that will take the dollar higher," said Daragh Maher, a strategist at HSBC.

"We think that the Fed will try and introduce some kind of forward guidance like lowering the unemployment threshold. So any dollar rally will be limited. On the other hand, if the Fed holds off we could see the euro rally against the dollar."

The Fed will announce its policy decision at 1900 GMT. Chairman Ben Bernanke will hold a news conference at 1930 GMT. In recent days, the odds have improved that the Fed will start tapering this week, keeping U.S. yields elevated and broadly helping the dollar.

Whenever the Fed chooses to move, most in the market expect it to trim its monthly $85 billion bond-buying program by $10 billion-15 billion at most. A no-taper decision on Wednesday could still dent the dollar, although it may hold its own against the yen, which tends to weaken when risk appetite rises.

Earlier, a widening Japanese trade deficit pulled the yen down. Data released on Wednesday showed Japan posted a deficit of 1.29 trillion yen ($12.56 billion) in November, marking a record 17 straight months of deficits as a weak yen inflated the cost of imported fuels.

"That trend (of rising deficits) may continue in advance of the April 2014 sales tax hike," said Chris Turner, head of FX strategy at ING.

"U.S. rates look like they will rise, and barring an equity market collapse on a surprise Fed taper, dollar/yen should push on to 105 by year-end. Large option expiries are keeping it glued to 103.00/50 currently."

Meanwhile, sterling jumped after UK unemployment fell by more than expected, raising expectations that rates might rise earlier than previously forecast. Sterling hit a session high of $1.6370, up 0.5 percent, while the euro fell 0.7 percent to 84.03 pence.

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