* Graphic: World FX rates in 2019 tmsnrt.rs/2egbfVh
By Saikat Chatterjee
LONDON, Feb 26 (Reuters) - The dollar rebounded on Wednesday from a two-week low hit in the previous session as investors scaled back expectations that the U.S. Federal Reserve would signal more policy easing in response to a deadly virus spreading outside China.
However, broader market sentiment remained cautious, with implied volatility gauges on euro/dollar rising to 4-1/2 month highs while commodity currencies like the Australian and the kiwi dollar came under fresh selling pressure.
“The broader theme of risk aversion is still impacting FX markets, though markets are starting to reprice some of their excessive policy easing expectations,” said Manuel Oliveri, a currency strategist at Credit Agricole In London.
That was evident in expected price swings for the euro currency, with one-month maturities rising to an early October high of 5.7% after hitting a six-year low of 2.3% last week.
But gyrations in derivatives had little impact on broader cash markets, with the single currency struggling to push above the $1.09 level on Wednesday. It was trading at $1.08760.
Commodity currencies came under some selling pressure, with the Aussie and the Kiwi dollar shedding half a percent each against a broadly sturdy greenback.
As the coronavirus outbreak started to spread quickly to the Middle East and Europe, some investors no longer saw the U.S. economy as immune and started to bet the Federal Reserve would have to cut interest rates to support growth.
But Fed Vice Chair Richard Clarida said on Tuesday that while the central bank is monitoring the impact of the epidemic on the U.S. economy, it is still too soon to gauge if it would require a change in monetary policy.
While money markets have also increased expectations of more cuts from the Fed, with interest rate futures now pricing in about 60 bps of cuts by the end of the year compared to 40 bps a month earlier, investors were slightly more cautious.
The bid-to-cover ratio, an indicator of demand, of a U.S. 2-year Treasury note auction was less than a similar sale, indicating hedge funds were not aggressively buying shorter-dated debt, expecting a more cautious Fed.
“The significant dovish tilt being priced in by markets from the FOMC may not materialise and that might cause the next leg of the dollar rally,” said Peter Chatwell, head of multi-asset strategy at Mizuho Bank.
Against a basket of its rivals, the dollar edged 0.1% higher to 99.04, recovering from two-week low of 98.876 hit in the previous session.
Reporting by Saikat Chatterjee; Editing by Angus MacSwan and Jan Harvey