Dollar rebounds as traders look beyond liftoff to rate-rise path

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(Bloomberg) -- The dollar rose a second day, rebounding from its biggest daily loss since March on Dec. 3, as traders refocus on the outlook for higher U.S. interest rates.

The U.S. currency strengthened against all of its 16 major peers as investors weighed the path of future rate increases after the projected December liftoff. St. Louis Federal Reserve Bank President James Bullard said the Fed should avoid predictable rate increases. The euro declined for a second day after European Central Bank President Mario Draghi said on Dec. 4 the ECB can deploy more stimulus, if necessary.

“The focus is increasingly on whether the market has sufficiently priced this lower- terminal-rate theme,” said Matt Derr, a foreign-exchange strategist in New York at Credit Suisse Group AG, referring to where the Fed’s rate target will stand at the end of its tightening cycle. “The less dovish ECB on its own allows the market to price more Fed hikes, as the Fed wouldn’t have to wrestle with as weak a euro-dollar exchange rate.”

The Bloomberg Dollar Spot Index, which tracks the performance of the currency versus 10 peers, gained 0.5 percent to 1,230.05 as of 2:51 p.m. New York time. The euro slid 0.3 percent to $1.0846, extending the 0.5 percent decline of Dec. 4.

Fed Watch

Investors are starting to consider whether the Fed’s emphasis on a measured increase in borrowing costs will be sustained after a payrolls report last week strengthened speculation the central bank will raise interest rates this month for the first time since 2006.

Traders see a 76 percent probability that the Fed will raise its benchmark rate at its Dec. 15-16 meeting, up from 68 percent a month ago, according to futures data compiled by Bloomberg. The calculation assumes the effective fed funds rate averages 0.375 percent after the first increase.

Investors are betting on three one-quarter-point increases during the next 12 months, fewer than the central bank’s own forecasts imply.

“We have to be more willing to pause if the data is weaker and speed up if the economy” accelerates, Bullard said. His main concern is that the Fed not lock itself “into any particular pattern,” he said.

While the pace of rate increases looks to be “slow and gradual,” from the middle of next year “we could start to see the effects of a stronger dollar start to taper off from inflation,” Bipan Rai, director of foreign-exchange strategy at Canadian Imperial Bank of Commerce’s CIBC World Markets unit, said from Toronto. “That could lead to a scenario where we’re looking at potentially a much steeper Fed trajectory than we are now, and that could be the second leg of this dollar bull run.”