Euro hits 2-1/2 year highs as warning signs grow

LONDON - 2 August 2017: The euro climbed to a fresh 2-1/2 year high against the dollar on Wednesday as investors added long bets in the single currency though some analysts advised caution as some signals such as interest rate differentials were flashing a warning sign.

While fears of a trade spat between China and the U.S. saw the U.S. currency score some early gains against its commodity-linked rivals such as the New Zealand and the Canadian dollar, it has struggled against the euro.

The euro briefly climbed to $1.1869, its highest since January 2015 before giving back some gains to trade 0.3 percent up at $1.1835 on the day.

"We see some dollar recovery in the fourth quarter as market expectations are rock bottom now so it might not take much to see some improvement," said Derek Halpenny, European head of FX research, Bank of Tokyo-Mitsubishi UFJ.

The dollar's weakness this year has been fuelled by a steady unwinding of expectations of optimism about U.S. President Donald Trump's stimulus plans and falling hopes to the extent of a Federal Reserve policy increase in the coming months.

For example, expectations of a U.S. rate increase at its September meeting has all but evaporated from the market compared to a 20 percent probability a month earlier, according to CME's Fedwatch tool.

But recent data has been encouraging. Last week's data showed the U.S. economy accelerated in the second quarter with market expectations focussed on jobs data this week.

Interest rate differentials are also pointing to a reversal in the dollar weakness trade. Two-year U.S. bond yields are now yielding 200 basis points more than their German counterparts, seven basis points more from a month ago.

The dollar index against a basket of major currencies was broadly flat at 92.96. On Tuesday, it hit its lowest level in 15 months at 92.777.

In contrast to the political risks and monetary policy uncertainty that have plagued the dollar, the common currency has drawn support from expectations that the European Central Bank would eventually begin phasing out its easy policy.

While the euro has been a star among its G10 peers this year, gaining more than 12 percent against the dollar with most of its gains coming in the last three months, some investors are growing cautious about the single currency's strength.

"Our European strategists advise selling the euro on rallies as they believe the ECB hawkish expectations priced into the market may be premature," said Sue Trinh, head of Asia FX strategy at RBC Capital Markets in Hong Kong.

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