Dollar supported as longer-run US rates seen higher

SINGAPORE (Reuters) -The dollar held firm and near recent peaks on Tuesday, on the eve of an expected interest rate cut in the United States, as traders have ratcheted long-term rate assumptions higher.

The friendless euro, which is heading for a calendar-year drop of nearly 5% on the dollar, was not far from recent troughs and traded at $1.0509 in the Asia session with markets in a holding pattern ahead of the Fed decision.

The gap between U.S. and German ten-year yields is 216 basis points and has widened nearly 70 bps in three months.

The yen was steady at 154.06 per dollar, after six straight days of selling as markets have pared chances of a Japanese rate hike this week in favour of a move in January.

The Federal Reserve announces its interest rate decision on Wednesday and interest rate futures imply a 94% chance of a cut, even as services-sector activity leapt to a three-year high according to an S&P Global purchasing managers survey.

The Atlanta Fed’s GDPNow indicator is running at 3.3% for the fourth quarter and the strength of the economy has been lifting yields and supporting the dollar as traders figure that the neutral setting for rates may be higher than first thought.

Fed officials’ median long-run interest rate projection was 2.9% in September. Market pricing implies almost no chance of rates being that low by December next year and only a 30% of the Fed Funds rate falling below 3.75% by the end of 2025.

“I think the Fed will now be worried about a resurgence of inflation as an unknown policy mix and sticky prices create many paths for inflation to make a comeback in 2025,” said Brent Donnelly, president at Spectra Markets.

“And therefore I think they will signal a very cautious approach going forward and lean on language that suggests concerns about inflation and a higher neutral rate.”

Besides the Fed, the Bank of Japan, Bank of England and Norges Bank meet this week and are expected to stand pat on Thursday, while the Riksbank is seen cutting rates, perhaps by 50 basis points.

Sterling bounced on Monday as a survey of business activity pointed to price rises in Britain while labour data is due on Tuesday, with upward pressure on wages seen adding to the case for caution from the central bank. Sterling last bought $1.2680.

The Canadian dollar, squeezed by falling interest rates and the risk of U.S. tariffs, sank to a 4-1/2 year low on Monday as the sudden resignation of Finance Minister Chrystia Freeland put an unpopular government under more pressure.

The Australian and New Zealand dollars are pinned near the year’s lows, though were spared any further selling on the latest weak Chinese economic indicators on Monday as markets bet that government spending will ride to the rescue. [AUD/]

The Aussie was last down 0.2% to $0.6356 and the kiwi slipped to $0.5769. New Zealand increased its bond issuance forecast for the next few years.

China’s yuan was steady at 7.2845 per dollar, as dour expectations for Chinese economic growth pinned 10-year bond yields near record lows.

Chinese leaders agreed last week to raise the budget deficit to a record 4% of gross domestic product next year, while maintaining an economic growth target of around 5%, two people with knowledge of the matter told Reuters.

(Reporting by Tom Westbrook; Editing by Shri Navaratnam)