Dollar Strengthens as Investors Consider Fed Leadership Under Warsh

Market Reactions to Fed Leadership

By Rae Wee

SINGAPORE, Feb 2 (Reuters) - The dollar clung to its gains on Monday as investors weighed what a Federal Reserve under Kevin Warsh might look like, with his preference for a smaller balance sheet.

The yen was also back on traders' radars, after Japanese Prime Minister Sanae Takaichi over the weekend talked up the benefits of a weaker yen in a campaign speech, in a tone at odds with her finance ministry that has worked to stem the currency's declines.

Impact on the Dollar

U.S. President Donald Trump's pick of Warsh as the next Fed Chair sparked a wave of selling across risky assets and sent precious metals tumbling on Friday, while the dollar clawed back its losses from earlier last week.

Yen's Performance and Future Outlook

While investors think Warsh will be inclined to cut rates, they expect him to rein in the Fed's balance sheet, which is typically supportive for the dollar as it reduces the money supply in the market.

The greenback remained on the front foot in early Asia trade on Monday, leaving the euro firmly away from the $1.20 level as it last stood at $1.1848.

Sterling was down 0.05% to $1.3680, while the dollar index steadied at 97.22 after jumping 1% on Friday.

Richard Clarida, PIMCO's global economic advisor and former Fed Vice Chair, said that while Warsh will inherit a Federal Open Market Committee that remains divided over the pace and scale of further policy easing, he believes Warsh will be able to deliver two rate cuts this year, and potentially even a third.

"Beyond those next two or three rate cuts, we believe Warsh may be more wary, depending on the inflation outlook," said Clarida.

"Warsh, based on his writings since leaving the Fed, may be much less likely to rely on extensive forward guidance about the future path of interest rates."

Elsewhere, the Australian dollar fell 0.54% to $0.69255, while the New Zealand dollar slid 0.3% to $0.6001.

YEN WEAKENS

The Japanese yen was down 0.4% to 155.39 per dollar on Monday, pressured in part by the dollar's strength and Takaichi's weekend comments which seemed to condone a weaker currency.

A survey by the Asahi newspaper showed that her party is likely to score a landslide victory in the upcoming lower house election.

Upcoming Japanese Elections

"The February 8 snap election is likely to be the next key local catalyst for the yen," said Tony Sycamore, a market analyst at IG.

"An LDP majority would likely push the USD/JPY toward 160, whereas a coalition outcome could leave the pair near the 155.00 level depending on the coalition partners."

Investors have sold the yen and Japanese government bonds in the run-up to the election, on expectations of more expansionary fiscal policy should Takaichi win a strong mandate, and that the tax cuts her party has touted would further strain already stretched government finances.

Still, the ailing yen has found a floor in recent times, as traders remain on alert to the prospect of a coordinated currency intervention by the U.S. and Japan after talks of rate checks from both sides late last month sent the currency surging.

(Reporting by Rae Wee; editing by Diane Craft)