Dollar buoyed by U.S. yields, hits one-week top ahead of ECB

© Reuters. FILE PHOTO: A U.S. dollar banknote is seen in this illustration taken May 26, 2020. REUTERS/Dado Ruvic/Illustration/File Photo

By Ritvik Carvalho

LONDON (Reuters) - The dollar rose to its highest in a week against peers on Wednesday, buoyed by higher Treasury yields and a weaker euro a day ahead of a European Central Bank policy decision.

The dollar index, which measures the currency against six rivals, traded 0.2% higher at 92.673 after earlier touching 92.732, a level not hit since Sept. 1.

The euro traded 0.2% lower at $1.1819 after hitting $1.1812, its lowest since Sept. 1.

Helped by higher U.S. yields, the greenback also hit a 3-1/2 week high of 110.45 yen before retreating to 110.20 yen.

The benchmark 10-year Treasury note rose as high as 1.385% on Tuesday, its highest since mid-July and a climb of almost 6 basis points from Friday's close. Monday was a U.S. holiday.

"We've seen the dollar move in lockstep higher with U.S. yields since markets have returned from the Labor Day holiday. The focus now turns to key central bank meetings - with the ECB tomorrow and the Fed later this month," said Viraj Patel, global FX and macro strategist at Vanda (NASDAQ:VNDA) Research.

"Whilst we've seen a dovish Fed reaction since Jackson Hole (and fuelled by last week's soft jobs report), the risks are that markets may be underestimating the odds of a hawkish September FOMC (Federal Open Markets Committee)."

The dollar index tumbled to its lowest since early August at the end of last week, when a surprisingly soft U.S. payrolls report prompted speculation the Federal Reserve will forgo announcing a taper of its stimulus at this month's policy meeting.

At the same time, strong wage growth warned of the potential for inflationary pressures to grow.

This week's dollar strength appears to be the result of a shift in investor focus to wage growth, which "suggests that the Fed may stick with its tapering plan," Ken Cheung, a strategist at Mizuho Bank in Hong Kong, wrote in a report.

"We look for further upside for the USD."

However, the surge in COVID-19 deaths in the United States could give the central bank pause. Reuters data shows that more than 20,800 people died from the virus in the past two weeks, up about two-thirds from the prior comparable period. President Joe Biden will outline a plan to tackle the highly contagious Delta variant on Thursday.

Investors will look to a speech by New York Fed President John Williams later on Wednesday for any hints on whether the labour market is still on the Fed's stated path of "substantial further progress" needed for a taper.

St. Louis Fed president James Bullard told the Financial Times that the central bank should go forward with a plan to start trimming stimulus this year despite the jobs slowdown last month.

"Risk aversion in the air alongside the move up in UST yields have helped the USD extend its post-payrolls recovery," Rodrigo Catril, a senior foreign-exchange strategist at National Australia Bank (OTC:NABZY), wrote in a client note.

"Investors are wary of the ECB meeting on Thursday, anticipating a potential trim to the PEPP (Pandemic Emergency Purchase Programme) bond-buying pace."

The European Central Bank could tighten policy sooner than many expect as inflationary pressures could prove to be persistent, ECB policymaker Robert Holzmann said in a contribution to Eurofi Magazine on Wednesday.

The ECB, which meets on Thursday, has kept policy ultra-easy since the start of the coronavirus pandemic, and it promised an even longer period of accommodation when it unveiled a new strategy in July. But inflationary pressure have built quicker over the summer months than many predicted.

Analysts polled by Reuters see PEPP purchases falling possibly as low as 60 billion euros a month from the current 80 billion, before a further fall early next year and the scheme's end in March.

Elsewhere, the Reserve Bank of Australia's decision on Tuesday to forge ahead with a taper of bond purchases while adding the dovish concession of extending the programme to February, helped undermine the Aussie dollar. It slipped 0.3% to $0.7366 on Wednesday, extending the previous session's 0.7% slide.

Canada's loonie was 0.2% lower at C$1.2674 per greenback after tumbling about 0.9% overnight.

Lower oil prices weighed, while investors anticipate a dovish narrative from the Bank of Canada's policy meeting later Wednesday following an unexpected economic contraction last quarter, NAB's Catril said.

Meanwhile, cryptocurrencies struggled to rebound from hefty losses overnight, when several trading platforms said they experienced performance issues, although it was not clear if these were a contributor to, or a result of, the volatility.

Bitcoin dipped 1.4% to around $46,212 after sinking as low as $42,900.01 on Tuesday. Earlier that day it had touched an almost four-month high of $52,956.47.