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Dollar tumbles as market digests Fed Treasury plans

NEW YORK (Reuters) - The dollar fell sharply for a second straight session on Thursday and the euro soared above $1.37 as investors feared the Federal Reserve’s government bond purchases would end up debasing the world’s reserve currency.

An employee of the Korea Exchange Bank counts one hundred dollar notes at the bank's headquarters in Seoul February 24, 2009. REUTERS/Jo Yong-Hak

The Fed said on Wednesday it will purchase $300 billion of long-dated Treasuries over the next six months, its first large-scale buying of government debt since the early 1960s.

It also said it will increase mortgage-backed debt purchases in a bid to rescue the economy, sending the dollar to its worst one-day loss since at least 1985 and sparking the biggest slide in U.S. benchmark Treasury yields since the 1987 stock market crash.

This raised fears that an expansion of the Fed’s balance sheet -- which has doubled in size in the past six months -- would lead to oversupply of the world’s main reserve currency.

“They are really cranking up the printing press, and that’s hurt the dollar,” said Andrew Wilkinson, senior market analyst at Interactive Brokers Group in Greenwich, Connecticut.

“The knee-jerk reaction is still to sell dollars, and that will probably see the euro rise into the $1.40s,” he said.

The euro rose as high as $1.3737, its best level since early January, and was last up 1.2 percent at $1.3665. On Wednesday, its 3.8 percent rise against the greenback marked its best day since its 1999 launch, according to Reuters data.

The dollar fell 1.4 percent to 94.48 yen after shedding nearly 3 percent a day ago, while sterling was last changing hands at $1.4514, up 1.3 percent on the day.

The dollar index .DXY, which measures the greenback against a basket of six major currencies, fell 1.3 percent after a 3 percent plunge on Wednesday, its biggest one-day drop in about of a quarter of a century, according to Reuters data.

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The decline in U.S. yields after the Fed’s move also dented demand for dollars, though traders said worries about dollar oversupply was the bigger drag on the currency.

OPTIMISM RUN AMOK?

The Fed’s move also seemed to reduce widespread fear in financial markets, undermining the safe-haven bid that has supported the dollar over recent months.

Currencies seen as more risky just days ago given the deteriorating global economy rose smartly on Thursday, among them the Australian dollar, Norwegian crown, and the Canadian dollar.

“Fear seems to have gone out the window,” Wilkinson said.

Some strategists said that view is probably too optimistic and predicted a more sober outlook on the U.S. and world economies once the post-Fed dust settles.

Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank in New York, said the worries about Japan’s economy would soon lead to renewed yen selling.

The euro, he said, also looked vulnerable above $1.40. “Europe still has a lot of skeletons in the closet,” particularly a severe recession in east Europe that is likely to get worse before it gets better, he said.

UBS strategists said the bank opened a long dollar trade against the euro at $1.37 and the yen at 94.00 on Thursday, adding that they expect bond yields around the world to follow U.S. yields lower in the coming weeks.

The Bank of England and Bank of Japan have already started buying government bonds, while The Swiss National bank shocked markets last week by selling francs to weaken its currency, another form of unorthodox monetary easing.

Analysts said these moves will put pressure on the European Central Bank to push rates toward zero and adopt its own extraordinary measures to boost growth.

“The last thing the ECB wants to see is the euro above $1.40, let alone $1.50,” said Bank of New York-Mellon senior currency strategist Michael Woolfolk.

Additional reporting by Vivianne Rodrigues; Editing by Diane Craft

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