Dollar Set for Weekly Decline Versus Euro as Policy Divide Fades

(Bloomberg) -- The divergence trade is taking a beating.

The dollar headed for its first decline in three weeks against the euro as investors reassess the monetary-policy paths of central banks in the U.S. and Europe. The greenback’s rally has been fueled by bets that the Federal Reserve may boost interest rates as soon as this month, while there was also speculation that the European Central Bank was set to boost its stimulus plan.

Both sides of that argument ran into roadblocks this week.

While a string of unexpectedly weak U.S. economic data prompted investors to trim their bets on the prospect of a rate increase by the Fed this month and weighed on the dollar, ECB President Mario Draghi Thursday damped expectations of a fresh round of stimulus and drove Europe’s shared currency higher.

The dollar weakened versus all of its 10 major peers this week as the futures-based odds of a Fed move on Sept. 21 saw a four-percentage-point decline to 28 percent. The U.S. currency was on course for its biggest weekly drop against the yen since the end of July. A speech due on Sept. 12 by Lael Brainard , a member of the Fed’s board of governors, will be in focus amid speculation she will strike a hawkish tone.

Fed Outlook

“In most people’s minds, September now is not a live month,” said Neil Mellor, a London-based currency strategist at Bank of New York Mellon Corp. “There are Fed members who want to keep alive the prospect of a September hike. We think December, which is really when the markets think is the most likely month for a hike.”

The dollar is down 0.6 percent this week to $1.1223 per euro as of 7:10 a.m. in New York. The U.S. currency rose 0.2 percent to 102.67 yen, set for a decline this week of 1.2 percent.

Traders were braced for “something more than a statement that all is well with the euro zone” from Draghi, according to BNY Mellon’s Mellor. There was “no elaboration at all on the prospect of easing. The market was expecting something, we didn’t get it and so obviously the euro has rallied higher on the back of that.”

Policy Pace

The dollar has been “pretty sluggish” for most of the year as markets have pushed back “expectations of Fed interest-rate hikes quite significantly,” according to Jane Foley, a senior currency strategist at Rabobank International in London.

While she said the U.S. currency may react to hawkish comments from Fed policy makers, Foley doesn’t think it will be easy “for the dollar to build up a lot of ground. An isolated interest-rate hike with months and months and months perhaps before the next one is probably not going to give the dollar too much upside traction.”

The drop to a six-year low in the ISM’s services gauge reported Tuesday was the latest in a series of weak data for August. Other less-than-stellar figures include an ISM factory survey showing a contraction in manufacturing, a cooling of hiring, automobile sales falling short of forecasts and an index of consumer sentiment at a four-month low.

--With assistance from Chikako Mogi To contact the reporter on this story: Anooja Debnath in London at adebnath@bloomberg.net. To contact the editors responsible for this story: David Goodman at dgoodman28@bloomberg.net, Keith Jenkins, Todd White