Dollar set for biggest two-day fall since 2009 as rate outlook shifts

By Amanda Cooper

LONDON (Reuters) -The dollar headed for its biggest two-day drop in almost 14 years on Friday, as investors piled into riskier assets after a cooler reading of U.S. inflation helped temper expectations for the Federal Reserve to keep raising rates as quickly.

Data on Thursday showed consumer inflation rose 7.7% year-on-year in October, its slowest rate since January and below forecasts for 8%.

The dollar staged its biggest drop since late 2015 on Thursday as Treasury yields plunged, while other currencies - the yen and the pound in particular - jumped.

Investor risk appetite got an additional boost from Chinese health authorities easing some of the country's strict COVID-19 restrictions, including shortening quarantine times for close contacts of cases and inbound travellers.

The dollar index was down nearly 1.1%, having lost over 3% in the last two days - its biggest two-day decline since March 2009.

Risk assets including stocks, emerging-market currencies and commodities rallied. But slowing inflation, while positive for borrowers, reflects a slowing economic backdrop, analysts said.

"It can be a little dangerous in that the 'bad news' is still out there and could come back to burn us, particularly with respect to the Fed," Rabobank currency strategist Jane Foley said.

The dollar has risen by 12% this year against a basket of major currencies, in light of the Fed's determination to bring inflation, which almost hit double digits earlier this year, back towards its target of 2%.

Other central banks have followed suit, with the exception of the Bank of Japan, and, as a result, the yen has witnessed its largest decline against the dollar since 1979.

The dollar, which has gained 22% in value against the yen this year, its steepest gain since 1979's 24% rise, was last down 1% against the Japanese currency at 139.54 yen.

The futures market shows investors are pricing in a 71.5% chance of a 50-basis-point U.S. rate increase next month, up from around 50/50 a week ago.

"We remain reluctant to jump in on the broader bearish dollar story just yet. First, because it simply appears too early to call victory in the inflation battle, and more evidence will need to come from the jobs markets - which has remained exceptionally tight," ING strategist Francesco Pesole said.

The yuan also jumped, as investors cheered the slight relaxation in China's COVID rules, despite cases rising sharply across the country.

The offshore yuan rallied by as much as 1.3% to hit its highest in over a month against the dollar, to 7.0592.

Sterling, meanwhile, pared overnight losses against the dollar and the euro after UK data showed the economy did not contract by as much as expected in the three months to September, although it is still entering what is likely to be a lengthy recession.

The pound rose 0.7% against the dollar to $1.179, having staged its largest one-day rally the day before since 2017, while against the euro it fell 0.4% to 87.47 pence.

The euro extended the previous day's 2% surge to rise 1.0% to $1.0311, trading around its highest since August.

It also briefly hit session lows versus the Swiss franc, after the head of the Swiss National Bank reiterated the central bank's commitment to bring inflation down. Against the franc, the euro was last down 0.42% at 0.9795.

Cryptocurrencies were under pressure again, given ongoing turmoil in the crypto world after exchange FTX's fall. FTX's native token, FTT, was last down 7.4% at $3.45 having fallen nearly 90% this month.

Bitcoin fell 1.3% to $17,348, after plunging below $16,000 for the first time since late 2020 this week.

(Additional reporting by Rae Wee in Singapore. Editing by Shri Navaratnam, John Stonestreet, Chizu Nomiyama and Mark Heinrich)