October 4, 2017 / 11:43 AM / a year ago

FOREX-Dollar rally stalls on talk of more dovish Fed chair

* Dollar hit by report Powell favoured to succeed Yellen

* Markets have largely priced in Fed rate hike in December

* Euro firms, shows little concern about Catalonia

* Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh

By Jemima Kelly and Fanny Potkin

LONDON, Oct 4 (Reuters) - The dollar dropped back from seven-week highs on Wednesday, amid speculation that U.S. President Donald Trump’s choice for the next head of the Federal Reserve could be a less hawkish candidate than had previously been expected.

The greenback had reached its highest since mid-August against a basket of major currencies on Tuesday, driven by stronger economic data, as well as expectations for another Fed rate hike by the end of the year and a revival of the so-called “Trumpflation trade”.

But it fell across the board on Wednesday, with investors concerned that the Fed might be set to take a more dovish turn after a Politico report that Fed Governor Jerome Powell is favoured over former governor Kevin Warsh by U.S. Treasury Secretary Steven Mnuchin.

While both are seen as serious candidates to replace current Chair Janet Yellen when her term expires in February, Powell is seen as more dovish than Warsh, who has criticised the Fed’s bond-buying programme in the past.

“Only a couple of days ago everyone was going for Warsh as successor, who the market saw as standing for a much tighter U.S. policy,” said Commerzbank’s head of currency research in Frankfurt, Ulrich Leuchtmann.

“Now everyone is thinking that Powell is the more likely choice and thinking of Powell as someone who will do very very gradual policy incrementations. Warsh is seen as sort of positive, Powell as a negative basically - that’s the most important factor at the moment.”

The euro climbed a quarter of a percent to $1.1770, off Tuesday’s 1-1/2-month low of $1.16955.

It has been dogged this week by worries over Catalonia, after a violence-marred independence referendum. But the common currency appeared largely unruffled by the region’s leader saying late on Tuesday that Catalonia would declare independence in a matter of days - comments that weighed Spanish bond prices.

“The political risk premium being priced into the euro is very small – in our view that’s too small and the risk is that we see some independent euro weakness on the back of that going forwards,” said RBC Capital Markets’ head of currency strategy Adam Cole, in London.

“But at the moment the (currency) market just doesn’t seem to care. The underlying assumption is that ultimately the constitutional court has ruled that the referendum is not legally binding, and that view will prevail.”

The dollar index slipped by a quarter of a percent to 93.437 , off a seven-week high of 93.92 touched on Tuesday following strong U.S. manufacturing figures.

Money market futures were pricing in about a 70 percent chance of a rate hike by December.

The dollar dipped 0.3 percent to 112.46 yen.

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Reporting by Jemima Kelly and Fanny Potkin; Additional reporting by Hideyuki Sano in Tokyo; Editing by Toby Chopra)

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