* Graphic: World FX rates in 2018 tmsnrt.rs/2egbfVh
By Saikat Chatterjee
LONDON, Oct 18 (Reuters) - The dollar stepped back from a one-week high on Thursday as investors took profits after a rally this week encouraged by upbeat Fed minutes signaling more rate hikes in store.
A pause in the greenback’s rally boosted emerging market currencies led by the Turkish Lira and pushed higher-yielding currencies such as the Australian dollar and the New Zealand dollar higher.
The minutes from the Fed’s Sept. 25-26 meeting showed every Fed policymaker backed raising interest rates and also generally agreed borrowing costs were set to rise further, despite U.S. President Donald Trump’s view that tightening has already gone too far.
Goldman Sachs strategists said the minutes confirmed market expectations of a rate increase in December. Two more are expected next year, according to swap markets.
“The minutes underscore the fact that the markets are vastly underestimating the Fed’s capacity to tighten,” said Win Thin, global head of FX strategy at Brown Brothers Harriman in a note.
“At some point, we think markets will start thinking about a fourth hike next year.”
Risk appetite was mixed across the board with the Swiss franc and the Japanese yen also gaining across the board.
While interest rate differentials haven’t played a big role in the first half of the year in predicting currency trends as trade war concerns have dominated sentiment, that relationship has begun to exert its influence again in recent weeks.
The gap between ten-year U.S. yields and German counterparts has widened out to three-decade highs of 274 basis points and market watchers expect the spread to widen more in the coming months.
“The minutes confirm that policymakers are expected to raise rates more over the next year and that is helping the dollar gain and the risk off moves last night in Asian stocks is also another factor,” said Richard Falkenhall, senior FX strategist at SEB in Stockholm.
Interest rate futures are now pricing in an 83 percent likelihood that the Fed raises rates in December, according to the CME Group’s FedWatch Tool, the fourth hike this year. Against a basket of its rivals , the dollar gained for a third consecutive day, up 0.2 percent at 95.78.
A semi-annual report by the U.S. Treasury report released overnight refrained from naming China directly as a currency manipulator though market watchers said Washington will closely monitor the Chinese currency’s moves.
Deutsche Bank strategists termed the report “as a bit of an escalation without being too dramatic”.
The Chinese currency traded in the offshore market was trading near a three-month low against the dollar at 6.9385 yuan per dollar.
The euro changed hands at $1.1519 on Thursday, up 0.2 percent versus the greenback, after losing 0.65 percent on Wednesday. The euro has lost less than a percent versus the dollar so far this month.
The British pound was flat versus the dollar on Thursday to $1.3110 after Prime Minister Theresa May said London is willing to discuss an extension of the transition period after Britain leaves the European Union. (Reporting by Saikat Chatterjee; Additional reporting by Vatsal Srivastava in SINGAPORE; Editing by Richard Balmforth)