dollar rises on u.s. yield gap

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    Dollar Rises the Most in 6 Weeks Versus Euro on U.S. Yield Gap

    March 19 (Bloomberg) -- The dollar had its biggest weekly gain against the euro in six weeks as the advantage in U.S. bond yields boosted demand for the currency.

    Gains in the dollar accelerated this week as the yield on the benchmark U.S. 10-year Treasury note rose to its highest in more than seven months. A slump in emerging market stocks, currencies and bonds also prompted investors to buy dollar-denominated assets, traders said.

    ``Higher interest rates benefit the dollar, and the perception that rates are going up here have supported demand for the currency,'' said John Cholakis, a currency trader in New York at Natexis Banques Populaires.

    Against the euro, the dollar rose 1 percent to $1.3326 as of 5 p.m. yesterday in New York, from $1.3458 on March 11, according to electronic currency-dealing system EBS. It gained 0.7 percent to 104.74 yen. The gains are the most since the week of Feb. 4 against the euro and Feb. 11 versus the yen.

    ``Having a 10-year Treasury note around 4.5 percent helps'' the dollar, said Meg Browne, currency trader at Brown Brothers Harriman & Co. in New York. ``Declines in emerging markets also sparked demand for the U.S. currency.''

    The yield on the benchmark 10-year Treasury note is up from below 4 percent last month. Browne said the dollar may rise as far as $1.32 per euro in coming days.

    Yield Premium

    The Fed will probably lift its target rate for overnight lending on March 22, the seventh increase since June, lifting the return on dollar-based deposits. An increase would put the Fed's rate 0.75 percentage point over the comparable European Central Bank rate, the widest difference in four years.

    Rising Treasury yields also whet the appetite of foreign investors. The yield 10-year Treasury on March 14 traded at a seven-month high of 4.58 percent, increasing the attraction of U.S. debt relative to other government bonds. It ended the week at 4.51 percent.

    Two-year U.S. Treasury note yields widened to 1.31 percentage points more than comparable German debt last week, a four-year high.

    ``If the Fed continues to raise rates by 25 basis points every meeting, then we will get a 2 percent gap with Europe and that will be significant,'' said Momtchil Pojarliev, senior currency manager in London at Invesco Asset Management, which invests about $80 billion in fixed-income assets. ``I am more bullish on the dollar.''

    `Enticing Money'

    The Fed, which raised interest rates in quarter percentage- point increments six times since June, will do so again at its March 22 monetary policy meeting, according to the median estimate of 92 economists surveyed by Bloomberg News.

    The Fed's target overnight rate is 2.5 percent and expected to reach 3.75 by year-end, based on the median estimate in a Bloomberg survey of economists. The European Central Bank's comparable rate is 2 percent.

    ``Rising U.S. interest rates are finally coming to support the U.S. dollar by enticing money back into the U.S.,'' said Kenichiro Ikezawa, who manages $1 billion in overseas debt at Daiwa SB Investments in Tokyo. ``That's a classic phenomenon we normally see as the Fed raises interest rates, but had not been seen so much in this tightening cycle. It's dollar-positive.''

    The dollar may gain to $1.325 per euro and 105.50 yen next week, Ikezawa said.

    Emerging Markets

    Emerging market bonds rose on Friday, recovering some of their losses after the worst week in almost a year. The yield spread for such bonds widened 24 basis points so far this week, JPMorgan's EMBI+ benchmark shows, the biggest increase since the week ending May 6. Wider spreads mean investors perceive more risk in owning emerging market bonds relative to the safety of U.S. Treasuries.

    Emerging-market stocks fell Thursday, with Egypt's CASE 30 Index leading declines, sinking 6.3 percent. Morgan Stanley Capital International Inc.'s Emerging Markets Index of stocks is down 3.4 percent this week, and mutual funds investing in emerging European, Middle Eastern and African stocks had their first weekly outflow of money in three months.

    ``When you get emerging markets under pressure, money tends to flow back into dollars,'' said Ian Gunner, head of currency research in London at Mellon Financial Corp., which oversees about $700 billion in assets. ``There is always some residual support for the currency.''

    Yen and Oil

    The yen also fell for the week, as oil traded near a record high, raising speculation it may stall economic growth in Japan, which imports almost all of its petroleum. Finance Minister Sadakazu Tanigaki said the government ``must closely watch oil prices because they affect the cost of various materials.''

    Crude oil slipped after touching records on Thursday on speculation that output will lag demand. Prices in New York rallied as much as 5.8 percent this week to an all-time high of $57.60 a barrel yesterday.

    Gains in the U.S. currency may be limited over concerns the U.S. will still fail to attract sufficient capital to offset its current account deficit. The shortfall in the current account was a record $187.9 billion in the fourth quarter, the Commerce Department said on Wednesday. The news sent the dollar down more than a cent on March 16, the only day this week it declined.

    ``The current account deficit is offsetting news about U.S. growth and rising rates,'' said Callum Henderson, head of global currency strategy in Singapore at Standard Chartered Plc.

    The U.S. needs to attract more than $2 billion a day in investments from abroad to compensate for the deficit and hold the dollar's value, according to Bloomberg calculations.
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