Yen hits two-week high on dovish Fed expectations; yuan rallies

By Tom Westbrook

SINGAPORE (Reuters) - The Japanese yen inched higher on Wednesday as traders bet an ultra-accommodative U.S. Federal Reserve would weigh on the U.S. dollar, while the Chinese yuan extended gains one day after data pointed to better prospects for the world's No. 2 economy.

The Fed is due to make its first policy statement since adopting a more tolerant approach to inflation later on Wednesday.

Traders bought yen on the belief the U.S. central bank may promise further stimulus, which would likely weaken the U.S. dollar and push Treasury yields lower. The Fed is not expected to move on rates but adjustments to bond purchases are possible.

The yen touched a two-week high of 105.25 per dollar, but investors reduced dollar shorts, or bets that the dollar would fall, after months of weakness in the greenback.

Against other majors, the dollar drifted lower or held steady -- last trading 0.1% softer against a basket of currencies (=USD) and a tad weaker on the Aussie and kiwi.

"Dollar/yen is one of the more attractive ways to play for a dovish Fed," said Westpac currency analyst Sean Callow, adding that the yen was particularly sensitive to the U.S. bond market given Japanese investors are large buyers of U.S. debt.

"You can brace yourself for some choppy price action around the announcement, but when the dust settles you would think that we'll be seeing a Fed that's leaning towards looser policy to match what they've already announced," Callow said.

Through the Asia session, the yen rose 0.2%. The Australian dollar rose by the same margin to $0.7317 and the New Zealand dollar edged higher to $0.6727.

The euro (EUR=) was steady at $1.1847 and sterling crept higher to $1.2914 on hopes that a British plan to break its Brexit treaty will not come to fruition.

The Fed decision is due at 1800 GMT followed by a news conference from chairman Jerome Powell half an hour later.

Besides immediate policy, a major focus will be on the Fed's economic projections, especially if it spells out where it sees inflation headed and what exactly that means for rates under its new regime.

Paucity of detail could lift the dollar a little, though analysts felt that would probably be short-lived.

"The market overall knows that the Fed wants to be dovish. It's just that the timing may not match what the market wants in terms of giving details in this meeting," said Bank of Singapore FX analyst Moh Siong Sim.

RUNAWAY YUAN

Beyond Fed positioning a soaring yuan was the other driver of trade in Asia on Wednesday. [CNY/]

In offshore trade, the Chinese currency made a fresh 16-month high, hitting 6.7652 per dollar as it extended a decisive leap in the wake of strong retail sales and industrial output data on Tuesday.

That pulled the South Korean won to a 7-month high and the Malaysian ringgit to its highest since February. [EMRG/FRX]

The strongest fixing of the yuan's onshore midpoint since May 2019 was also seen as signal that policymakers don't mind a strong currency amid a broader policy shift towards growing China's domestic economy.

The yuan has risen more than 5% over the past four months.

"The Chinese currency is, for me, the surprise of the year since May," said Davis Hall, head of capital markets in Asia at Indosuez Wealth Management.

"People are starting to embrace a new theme, which is that China is managing much, much better than anyone else," he said.

"China, effectively, while they move their business model towards an internal demand story, wants to have a stronger currency to reduce their commodity import bill," he said. "They can live now, with a stronger currency, with much less need to devalue."