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Dollar set to sail ahead if Fed delivers rate hike

NEW YORK: The dollar should sail ahead this week if the Federal Reserve delivers what investors expect: a rate hike big enough to slow robust US growth without worrying Wall Street, currency analysts said on Monday.

"There are still reasons to believe that the dollar will be positively supported in light of all issues facing the market," said Eric Nickerson, currency strategist at Bank of America.

About 24 hours before the Fed's news, the dollar was trading nearly flat against the euro at just above 97 cents per euro, and off a touch against the yen at 106.37 yen per dollar.

While dealers said the so-called event risk would keep trading subdued until Fed announces its decision, many players said the market is ready to move ahead simply because the idea of another rate hike has been so well discounted.

For weeks, Wall Street's 30 primary dealers have been sure the policy-setting Federal Open Market Committee (FOMC) will push its key federal funds rate up a quarter point to 6 percent.

Even interest rate-sensitive bond and stock markets appear to have adjusted to rising interest rates, recovering well since last week's inflation reports suggested there was little to worry about now.

Higher commodity prices have pushed up headline inflation figures, but without the volatile food and energy readings, analysts agreed inflation remains under control.

With no obvious need for the Fed to tap the interest rate brakes any harder than expected this week, dealers said the dollar's biggest risk factor may be the language of the statement the Fed issues when it announces its decision.

But even there, dealers agreed the chances for a market moving surprise are relatively low.

"A hawkish statement from the Fed is unlikely to have a very negative effect on US assets and with little out in terms of economic data, we expect this to be a positive week for the dollar," said Tomas Jelf, currency analyst at Warburg Dillon Read.

Dealers said the dollar should be able to gain ground against the euro since a US rate hike should eclipse the positive effect from last week's quarter point European rate hike. "As long as the US and Europe keep hiking more or less in tandem and there are dangers for the euro like the German metal workers' union's threat to strike, the dollar should do better," a New York-based trader said.

Analysts at FleetBoston said "we continue to expect that the growth differential will stay wide, leading to further euro downside," even though European Central Bank President Wim Duisenberg and others boasted about growth in the region.

Similarly the dollar is likely to hold its own against the yen because the annual shift of funds home by Japanese investors in time for fiscal year end on March 31 appears to have ended, offering investors new opportunities to establish short yen positions.

But dealers admitted the dollar could still hit some rough spots, especially if the market becomes nervous about America's growing trade and current account deficits.

Fed officials like William McDonough, president of the Federal Reserve Bank of New York, have expressed concern about the high current account deficit, warning there could come a time when foreign investors tire of funding the US gap.

"This could be the factor that could bring some uncertainty for the dollar," Bank of America's Nickerson said.-Reuters