Dollar under pressure amid QE2 speculation Posted by naila , Thursday, October 7, 2010 at 4:23 PM, in Labels: business

Selling the dollar has been a one-way trade recently, as the Federal Reserve looks poised to pump more cash into the economy next month, but the bulk of the impact of extra easing may now be priced in.

The dollar lost 8.5 per cent against a basket of six major rivals last quarter, the most in eight years, on fears money-printing by the central bank will debase the currency.

Speculators pushed bets against the greenback to $22 billion in the week ended September 28, the highest since at least mid-2008. The dollar’s downtrend comes at a time when many other countries are trying to weaken their currencies or at least slow their appreciation. That has fuelled fears a global currency war could derail economic recovery.

The fall in the dollar has been so dramatic that some now believe the market may be getting ahead of itself, setting up investors for disappointment should policymakers fail to deliver. “The risk is that once it becomes reality, it will be a smaller program than the market thought and that will be a catalyst for a dollar bounce,” said Richard Franulovich, senior currency strategist at Westpac in New York.

“There’s too much division (within the Fed). There’s no way you can get a big program in place, like $1 trillion, with that much division,” he added.

While some Fed officials like New York Fed President William Dudley said more action was warranted, Dallas Fed Bank chief Richard Fisher and others believe a further relaxation of monetary policy might do more harm than good. The Fed has already pumped $1.7 trillion into the economy through purchases of Treasuries and mortgage-related debt.

If the Fed does decide to purchase more bonds, many economists said it would likely opt for a gradual, open-ended approach and a smaller amount than the first round of quantitative easing (QE) implemented in March, 2009. QE is seen as negative for the dollar because it tends to lead to higher inflation expectations and lower real rates.

UBS does not expect any Fed action, though it said there was risk around that view. The bank targets euro/dollar at $1.25 in three months.

Fed officials and investors will be in data-watching mode ahead of the central bank’s next meeting on November 2-3, with the key September jobs report due out this Friday and the first estimate of third-quarter growth on October 29. Surprisingly, strong data could shake expectations for the Fed, forcing a squeeze of dollar shorts.