NEW YORK (Reuters) - The dollar fell against the Japanese yen but clawed back most of its earlier losses against the euro on Thursday in thin trading as investors looked ahead to Federal Reserve interest rate cuts next year.
The dollar index, which measures the US currency against six rivals, fell to a fresh five-month low of 100.61 and was last down 0.05% on the day at 100.82. The index is on course for a 2.58% decline this year, snapping two straight years of strong gains.
The greenback has declined as expectations of rate cuts have increased, notably after the Fed's unexpectedly dovish stance at its December meeting.
“The market has gotten even more aggressive on Fed easing,” said Marc Chandler, chief market strategist at Bannockburn Global Forex in New York.
Markets see the Fed's first rate cut coming in March and are pricing in 156 basis points of easing by next December.
The day's biggest mover was the Japanese yen. The dollar dropped as much as 0.82% to 140.66 yen, its lowest since July 28, and was last down 0.73% at 140.78. The greenback remains on track for a 7.38% gain against the currency this year.
The yen is a popular funding currency, in which hedge funds and other investors use the proceeds from selling the currency to invest in other assets. However, as the Bank of Japan (BOJ) appears closer to ending its negative interest rate policy many traders are exiting these positions.
Investors short the funding currencies "are evening up,” said Chandler.
“This year it’s been a story of Fed tightening and BOJ teasing the market with the tweaking of the yield curve adjustment. Next year the position is going to be reversed, the market expects the BOJ to raise rates, and the Fed to ease rates. A fundamental driver’s going to change.”
Net shorts in the yen against the US dollar fell to 64,902 contracts in the latest week ending Dec. 19, compared to 81,131 the previous week, according to data from the Commodity Futures Trading Commission.
With inflation exceeding its 2% target for well over a year, many market players expect the BOJ to raise rates next year with some betting on the chance of action as early as in January.
BOJ Governor Kazuo Ueda, however, said he was in no rush to unwind ultra-loose monetary policy as the risk of inflation running well above 2% and accelerating was small, public broadcaster NHK reported on Wednesday.
The euro was last down 0.02% at $1.1103, having touched a five-month peak of $1.11395 earlier in the session. The single currency is heading for a yearly gain of 3.62%, its strongest performance since 2020.
Sterling rose to $1.2825, its highest since August 1, and was last down 0.21% at $1.2772. The pound is on track for a 5.61% return this year, its biggest since 2017.
The Swiss franc firmed to 0.8339 per dollar, its strongest level since January 2015 when the Swiss National Bank discontinued its policy of having a minimum exchange rate against the euro.