FOREX-Dollar falls as Fed cut highlights low yield status

The dollar weakened against the euro and yen on Wednesday, erasing gains made after a smaller-than-expected U.S. interest rate cut the previous day, as dealers maintained their bearish view on the low-yielding currency.

The Federal Reserve lowered its federal funds target rate on Tuesday by 75 basis points to 2.25 percent -- futures markets had broadly expected a full percentage point reduction -- which fuelled a relief rally in equities, tightening of a broad range of spreads and a rebound in the dollar.

The Fed's move gave an extra boost to stocks and broad market sentiment which had already been lifted by earnings reports from Lehman Brothers (LEH.N: Quote, Profile, Research) and Goldman Sachs (GS.N: Quote, Profile, Research). These weren't as gloomy as many analysts had feared, particularly following the near collapse of Bear Stearns (BSC.N: Quote, Profile, Research).

But the dollar's rally fizzled out in Asia. It was unable to hold above 100 yen, while implied volatilities on currency options edged back up as the dollar's bounce drew in sellers who were more worried about the currency's meagre yield and U.S. economy's bleak prospects.

"The Fed (cut) was a little bit less than what people were expecting although it gave some comfort to equity markets ... but the dollar is back under pressure again and that's reflective of the uncertainty over the U.S. economic outlook and the systemic risk (in the banking system)," said Phyllis Papadavid, currency strategist at Societe Generale in London.

"The dollar is losing its status as a safe-haven currency, and to the extent that these (financial market) uncertainties persist, the yen and Swiss franc will continue to benefit. Our bias is still to be short the dollar and recommend being short the dollar," she said.