August 25, 2011 / 8:25 PM / in 6 years

FOREX-Dollar gains on stock selloff, bets on Bernanke speech

5 Min Read

* Investors brace for Friday speech by Fed's Bernanke

* Dollar could gain if Bernanke does not signal QE3 (Updates prices, adds comment, details, changes byline)

By Steven C. Johnson

NEW YORK, Aug 25 (Reuters) - The dollar rose on Thursday and stocks slumped as investors shied away from risky trades amid speculation that Federal Reserve chief Ben Bernanke will not hint at new plans to stimulate the economy this week.

Talk that Germany might follow other European countries by banning short-selling also pushed the euro lower, erasing gains seen after news that Berkshire Hathaway (BRKa.N) would invest $5 billion in Bank of America (BAC.N). For more see [ID:nN1E77O0ET].

Though a German Finance Ministry spokesman said there were no plans to ban short-selling, the damage to European stocks had been done, and that rippled through U.S. markets. [ID:nB4E7JF02O]

The dollar tends to rise when markets grow nervous because investors cut trades funded with the U.S. currency. Low U.S. interest rates let investors borrow dollars at almost no cost.

Fading expectations of more Fed easing -- markets came into the week thinking Bernanke could announce a third round of asset purchases or some other extraordinary policy when he speaks on Friday in Jackson Hole, Wyoming -- are also good for the dollar and bad for stocks and risk appetite.

Under quantitative easing, the Fed prints money to buy bonds, which should depress U.S. Treasury yields and encourage investors to seek higher returns elsewhere. An increase in the money supply erodes the value of the dollar.

"We spent the better part of this week pricing in a QE3 announcement. Now we're seeing some give-back. and the more QE3 is priced out, the more the dollar will strengthen," said Brian Dolan, chief strategist at Forex.com in Bedminster, New Jersey.

If the Fed does refrain from injecting more dollars into the system, Dolan said the currency could extend gains sharply as investors pull out of stocks and other risky assets. A euro slide below $1.4250 could speed up greenback gains, he said.

The euro fell 0.2 percent to $1.4380 EUR=, though it recovered from a global session low of $1.4325.

The dollar rose to 77.48 yen JPY=, up 0.7 percent. It hit a record low beneath 76 yen last week. The dollar also hit a one-week high just shy of 0.8000 Swiss francs before easing to 0.7932 francs, down 0.3 percent CHF=EBS.

The dollar could rack up more gains against both currencies if Bernanke holds off on QE3, said Boris Schlossberg, director of currency research at GFT in New York.

"Should that scenario turn out to be true, the greenback could climb to 78.00 yen and could finally retake the 0.80 barrier against the Swissie as fears of further dilution of the currency begin to dissipate," he said.

Some analysts still think Bernanke may signal the Fed is ready to act if necessary, which could help riskier currencies including the Australian and New Zealand dollars.

Handicapping the euro's next moves is tougher: Investors shrugged off a surge in Greek bond yields GR2YT=TWEB, which rose on fear a planned second Greek bailout may yet unravel. But analysts said market focus will return to Europe's debt crisis after Bernanke's speech.

Fed data showed the U.S. central bank conducted $500 million of currency swaps with the European Central Bank in the week ended Aug. 24, suggesting some strains in short-term funding markets. [ID:nN1E77O1N0]

Some European banks have had to pay more to fund short-term U.S. operations lately due to fear they may be exposed to debt from troubled euro zone countries. [ID:nN1E77O18R]

Yet some traders said Chinese demand for euros will cap the currency's losses. [ID:nB9E7J201Z]

"China has not wavered in its support of the euro and the euro zone," said Douglas Borthwick, managing director at Faros Trading in Stamford, Connecticut. "We believe China, other Asian central banks and Middle Eastern reserve managers' euro/dollar purchases will continue at a gradual pace." (Additional reporting by Wanfeng Zhou; Editing by James Dalgleish and Leslie Adler)

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