FOREX-Dollar stabilizes after losses on emerging market turmoil

Mon Jan 27, 2014 12:13pm EST

* Dollar/yen hits lowest level since early December

* Dollar pares gains after weaker-than-expected new home sales

* Recent selloff in EM FX supports demand for safe havens

* Euro pops up after German IFO, then slips

By Richard Leong

NEW YORK, Jan 27 (Reuters) - The dollar held steady against the yen and the Swiss franc on Monday, stabilizing against those safe-haven currencies after losses last week stemming from a selloff in emerging markets assets picked up pace.

Expectations the U.S. Federal Reserve may further reduce its bond-purchase stimulus this week halted the decline in the dollar, which has fallen nearly 2 percent in the past three sessions.

The greenback is vulnerable to more losses if more investors scramble out of emerging markets on concerns about a foreign exchange crisis in Argentina and the Turkish central bank's ability to keep interest rates low. The stampede out of emerging economies has rippled across global markets.

"The market is looking to sell risk ahead of the Fed meeting," said Michael Woolfolk, senior market strategist at Bank of New York Mellon in New York.

A rebound in two-year Treasury yields helped the dollar to 102.39 yen, up 0.1 percent on the day. It had fallen to 101.77 yen, its lowest since early December, in early Asian trade when liquidity was thin.

The dollar rose 0.1 percent against the Swiss franc, bouncing from a one-month low struck on Friday. The euro also rose 0.2 percent to 1.2254 francs having fallen to a one-month low of 1.2227 francs on Friday when demand for the yen and Swiss franc intensified.

"Emerging market currencies remain vulnerable to a selloff if the Fed continues to taper and that should keep the dollar supported," said Jane Foley, senior currency strategist at Rabobank in London.

The dollar retreated from its New York session high versus the yen and Swiss franc. Weaker-than-expected data on new home sales in December raised some doubts whether the U.S. economy is strong enough to grow with less Fed stimulus.

"We had a negative response on the new home sales data," Woolfolk said.

The Commerce Department said new home sales fell 7.0 percent to a seasonally adjusted annual rate of 414,000 units, short of the 457,000 unit clip forecast by analysts.

"The yen is now the only G10 currency that consistently trades as a safe haven and as such, should be the natural beneficiary of ongoing pressure on EM currencies," said Adam Cole, head of G10 FX strategy at RBC Capital.

Some of the nervousness was reflected in the options market where one-month implied volatility - a measure of how sharp swings are likely to be - in dollar/yen rose to its highest in five weeks. The one-month dollar/yen implied vol rose to 9.6 percent, having traded at 7.95 percent on Thursday.

Emerging market (EM) currencies from Turkey to Argentina remained under pressure, making investors nervous that the shakeout in markets could lead to a full-blown crisis.

In Turkey, a graft investigation is posing one of the biggest threats to Prime Minister Tayyip Erdogan's 11-year rule, while Argentina abandoned support of its peso on the open market last week, sending the currency skidding to its biggest drop since the 2002 financial crisis.

An underlying concern is that a less accommodative U.S. monetary policy is encouraging a shift of funds back to the United States from emerging markets. These markets had enjoyed a flood of cheap money from the Fed's money printing program, known as quantitative easing. The flood of dollars had hurt its value against other currencies before the Fed signaled its intention to scale back QE last May.

Fed policymakers will meet on Tuesday and Wednesday. They are expected to reduce the third round of QE by $10 billion to $65 billion in February.

In addition, tightening credit conditions in China, as the government seeks to curb growth in high-risk lending, heightened fears about a possible slowdown.

The euro slipped against the dollar to $1.3678, having risen to an European session high of $1.3716 after German IFO numbers. German business morale climbed in January to its highest level since July 2011, suggesting Europe's largest economy is on track for a strong start to 2014..

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