Dollar subdued near seven-week low, investors edgy about Fed policy

[December 15, 2015]  By Anirban Nag

LONDON (Reuters) - The dollar fell to a seven-week low against a basket of currencies on Tuesday, with investors cutting favorable bets in the currency on growing nervousness about the Federal Reserve's message on interest rates later this week.

Investors were also turning less bearish on the euro going into the year-end. Traders said many investors were unwinding positions where they have sold the euro to buy higher-yielding but riskier assets or currencies amid jitters in the high-yield corporate debt market in the United States.

A toxic combination of plunging oil prices and the prospect of a U.S. rate rise has caused stress in the junk bond market over the past week, with some high-profile funds forced to halt redemptions as yield spreads have ballooned.

The stress has caused some volatility in global stock markets and led some to question whether the Federal Reserve can raise interest rates.

As such, the U.S. currency was vulnerable to any surprise from the two-day Fed meeting that ends on Wednesday. The Fed is widely expected to hike interest rates for the first time in almost a decade but has hinted it intends to raise them only gradually, a stance deemed by many as relatively dovish.

"Given all the concerns, there is a risk that the Fed could opt for a dovish rate hike and downgrade the path for future rate increases," said Yujiro Goto, currency strategist at Nomura. Currently, the Fed's rate path is signaling at least four hikes over the course of the next year, and any downgrade could weigh on the dollar, Goto added.

The dollar index fell to a low of 97.19 and was last trading at 97.47, down 0.15 percent. The euro was up 0.2 percent at $1.1011, having hit a seven-week high of $1.1060 earlier in the day. A robust German ZEW also supported the euro, traders said.

Nevertheless, most of the attention was on how the dollar would react after Wednesday's Fed decision.

"Fresh fear and loathing about the impending Fed rate hike and the risk-off evident in junk bonds, equities and emerging markets – not to mention the deflationary risks from a devaluing China and a fresh implosion in oil prices – will mean that the Fed tiptoes into this rate hike cycle with extremely cautious guidance," said John Hardy, head of strategy at Saxo.

Meanwhile, the Swedish crown rose after the Riksbank kept rates unchanged. The euro fell 0.7 percent to 9.2570 crowns from around 9.34 crowns beforehand.

Analysts said the European Central Bank's less expansionary than expected policy easing earlier this month had given the Swedish central bank some breathing space as it attempts to keep the crown weak and bolster exports and growth.

(Editing by Catherine Evans and Gareth Jones)

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