Dollar Advances for Third Straight Quarter Against Euro, Yen

Oct. 1 (Bloomberg) -- The dollar capped its third straight quarterly gain against the euro and the yen, the longest winning streak since 2001, as the Federal Reserve maintained its pledge to raise interest rates at a "measured'' pace. The U.S. currency rose 2.3 percent against the yen and 0.7 percent versus the euro in the past three months as the Fed lifted its benchmark rate twice, to 3.75 percent. The European Central Bank has kept its rate at 2 percent for two years, while the Bank of Japan has maintained rates near zero since 2001. "People are willing to hold dollars,'' said Gerry Celaya, chief strategist at Redtower Research, a market research firm in Montrose, Scotland. "People are coming around to the view that the Fed is going to keep raising rates". The dollar strengthened 1 percent this week to 113.50 yen, its third straight weekly gain, at 5 p.m. yesterday in New York, according to currency dealing system EBS. The U.S. currency gained 0.1 percent to $1.2026 per euro. Celaya said the dollar will rally to $1.13 per euro and 125 yen by year-end. Redtower was the most accurate forecaster of foreign-exchange rates in the second quarter, according to a Bloomberg survey. The dollar was also bolstered as the yield advantage of Treasury notes over European government debt widened last quarter to the most in more than six years. The Fed last month said the U.S. economy faces only a "near-term'' setback from Hurricane Katrina, the nation's most costly natural disaster, and pledged to stick to its policy of raising rates at a "measured'' pace.

Yield Advantage
"The Fed has given all impressions that they intend to keep raising rates,'' said Tim Mazanec, senior currency strategist in Boston at Investors Bank & Trust Co. "That has spurred interest in the dollar.'' The yield advantage of 10-year Treasuries over German government bonds with a similar maturity is 1.19 percentage points, near the widest since July 1999. Versus Japanese government bonds, the spread is 2.84 percentage points. The gap with Japan has averaged 2.87 percentage points this year and reached as much as 3.27 percentage points on March 28.
"Japanese investors are buying the dollar to purchase overseas assets, such as Treasuries,'' said Luke Waddington, head of interbank currency sales Royal Bank of Scotland Plc in Tokyo. Japanese investment abroad is being led by a surge in purchases of foreign bonds. Japan's investors, including the central bank, held $683 billion of Treasuries in July, more than any other country, and they were net buyers of foreign bonds for all but two weeks this quarter, according to U.S. Treasury Department figures.

Dollar Story
The Fed's six quarter-point rate increases in 2005 helped spur a 10 percent gain in the dollar versus the yen and a 12 percent rally against the euro this year. "It really is a U.S. dollar story,'' said Clifford Bennett, chief strategist in Sydney at FxMax. The Fed will lift rates to 4 percent at its meeting on Nov. 1, he said. The National Association of Purchasing Management-Chicago said yesterday that its Business Barometer, which is based on a survey of executives in the region, rose to 60.5 this month from 49.2 in August. A number higher than 50 signals growth.
A separate survey showed U.S. consumer confidence fell by the most in 15 years. The University of Michigan's final index for September fell to 76.9 from 89.1 a month earlier, the same as was first reported on Sept. 16. The yen may be supported after Bank of Japan Governor Toshihiko Fukui said this week the central bank might stop pumping money into the economy as soon as April and forecast inflation may return after a seven-year absence. Fukui's remarks at a press conference in Osaka were the first time a BOJ official has indicated a timetable for ending its policy of holding interest rates near zero. "The yen is relatively undervalued,'' said Ashley Davies, a currency strategist in Singapore at UBS AG. Fukui "signaled the BOJ is surprisingly flexible in when it changes its policy.''
The yen may gain to 109 against the dollar in the next month, Davies said. Investors should increase bets the yen will gain versus the euro on speculation the BOJ will change its policy, Lehman Brothers Holdings Inc. said. Japan's currency has fallen about 2 percent against the euro in the past three months. "The yen looks too cheap in a world where the BOJ may be removing its zero-rate policy in the months ahead,'' wrote James McCormick, Lehman's head of global currency research in London, in a report sent to clients this week. "Yen fundamentals are increasingly too strong, and the currency too weak, to justify further declines.''