NEW YORK: The dollar rose against the yen and the euro, helped by a rise in U.S. Treasury yields, as investors adjusted positions ahead of a Federal Reserve decision on Wednesday on whether to start paring back monetary stimulus this month.
Many market participants do not expect any major policy change from the Fed with regard to its bond-buying program, but in recent days the perceived chance that the Fed will start tapering this week has risen. That has kept yields on U.S. 10-year notes elevated, broadly helping the dollar.
The Fed will announce its policy decision at 1900 GMT. Chairman Ben Bernanke will hold a news conference at 1930 GMT.
"Our base-case scenario is for a small amount of tapering this month ($5 to $10 billion) followed by a non-committal outlook for further reductions that would minimize the market's reaction and give (White House-appointed Fed Chair) Janet Yellen the flexibility to design her own strategy for unwinding stimulus," said Kathy Lien, managing director at BK Asset Management in New York.
The euro slipped to $1.3746 while the dollar rose 0.4 percent against the yen to 103.05 yen.
The euro shrugged off a German IFO survey that was in line with expectations. Year-end repatriation flows and higher money-market rates continued to lend it support before the Fed's decision.
Euro/dollar overnight implied volatilities - a gauge of how sharp price swings can be - shot up on Wednesday before a possible move by the Fed. The overnight euro implied vols more than doubled to 13.70 percent from around 5.5 percent on Tuesday.
Strong November U.S. housing starts, meanwhile, failed to ignite a reaction in the forex market, but they did add to growing evidence that the world's largest economy is on a steady path to recovery. Housing starts surged to their highest in nearly six years, jumping 22.7 percent.
For Andrew Wilkinson, chief economic strategist at Miller, Tabak &Co, the robust housing starts report justifies the firm's call for a small amount of Fed tapering this month.
"We see the economy better positioned and poised for strengthening growth into next year," Wilkinson said. "Recent hiring in construction and continued buoyancy as the housing market builds momentum vindicates our stance and the latest blockbuster report did not disappoint."
Should the Fed choose to move, most in the market expect it to trim its monthly $85 billion bond-buying program by $10 billion to $15 billion at most. A no-taper decision on Wednesday could still dent the dollar, although it may hold its own against the yen, which tends to weaken when risk appetite rises.
Earlier, a widening Japanese trade deficit pulled the yen down. Data released on Wednesday showed Japan posted a deficit of 1.29 trillion yen ($12.56 billion) in November, marking a record 17 straight months of deficits as a weak yen inflated the cost of imported fuels.
"That trend (of rising deficits) may continue in advance of the April 2014 sales tax hike," said Chris Turner, head of FX strategy at ING.
"U.S. rates look like they will rise, and barring an equity market collapse on a surprise Fed taper, dollar/yen should push on to 105 by year-end. Large option expiries are keeping it glued to 103.00/50 currently."
Meanwhile, sterling jumped after UK unemployment fell by more than expected, raising expectations that rates might rise earlier than previously forecast. Sterling hit a session high of $1.6389 and was last up 0.7 percent at $1.6382. The euro, meanwhile, dropped 0.9 percent to 83.90 pence.
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