September 26, 2014 / 11:14 AM / 5 years ago

FOREX-Dollar heads for 11th weekly gain but tensions grow

* Dollar recovers after stumbling on U.S. stock sell-off

* Back on rise against yen, flat against the euro

* Graphic on USD vs Treasury yield

* link.reuters.com/gak92w (Adds more quotes, updates prices)

By Patrick Graham

LONDON, Sept 26 (Reuters) - The dollar nudged higher against the yen on Friday, on track for an 11th straight weekly gain against a basket of currencies that would extend the longest winning streak since its 1971 free float.

Concerns about the U.S. currency’s 7 percent rise against the basket of major currencies since early July surfaced in a sell-off on New York stock markets on Thursday, and the rally that most investment houses expect to continue through next year may not be a smooth affair.

But the growing divergence of economic fortunes, and market interest rates, on either side of the Atlantic continues to drive a seismic shift that has some major banks forecasting a 15-20 percent fall for the euro over the next year.

After a retreat for the dollar overnight, Japan’s welfare minister pushed the yen lower by quelling speculation that reform of the country’s giant pension fund would be delayed. The changes are expected to result in more investment being channelled into Japanese equities and overseas assets and have hurt the yen.

“Fundamentally we see USD outperformance as one of the strongest G10 stories in the fourth quarter,” said Josh O’Byrne, a strategist at U.S. bank Citi. “There is still considerable room before a complete recovery (is in place), but demand for U.S. assets is on the rise.”

The euro was steady in early European trade at $1.2744, off an almost two-year low of $1.26955 hit on Thursday. The dollar index, measuring it against a basket of currencies, was just below a four-year high of 85.485 hit on Thursday.

FALLOUT

It is hard to find voices questioning the dollar’s ability to rise further but one big question for the rally will be the fallout in other markets of some of the preconditions for a stronger U.S. currency.

The prospect of an end to the Federal Reserve’s bond-buying programme, due next month, and of higher U.S. interest rates next year, drove a shocking sell-off on emerging markets early this year and Wall Street’s losses overnight had similar roots.

“We are coming to the end of a four- to five-year trend on markets and history tells us that does not tend to happen quietly,” said Neil Mellor, a strategist with Bank of New York Mellon in London.

“Just playing devil’s advocate, it would only take a few more dovish words from (Fed chief) Janet Yellen to halt this in its tracks and we know that the Fed has previous for that sort of turnaround.”

Mellor’s forecast for next year for the euro in the low $1.20s is one of the more conservative around. “But the way things are going we could get there fairly quickly,” he said.

Another issue is how palatable such large currency moves will be for officials. New York Federal Reserve President William Dudley said this week the value of the dollar was not a target for the Fed, but would be taken into account when setting policy.

Japanese Prime Minister Shinzo Abe also said earlier this week that he would carefully watch the impact of the yen’s fall to a six-year low.

“Many in the market feel the authorities won’t start verbal intervention until dollar/yen rises above 110,” said Masashi Murata, a senior currency strategist at Brown Brothers Harriman in Tokyo.

“Abe did touch on the yen this week, but fundamental demerits of a weaker currency are yet to stand out. For example prices of gasoline, crucial to regional economies, have not risen despite a depreciating yen, and he may have spoken merely to counter his critics,” he said.

The dollar rose 0.25 percent to 109.00 yen after slipping to as low as 108.47, off last week’s six-year high of 109.46 yen. (Additional reporting by Shinichi Saoshiro and Hideyuki Sano in Tokyo; Editing by Catherine Evans)

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