Dollar off on Fed unease; China data puts floor under stocks

By Leah Schnurr

NEW YORK (Reuters) - The dollar fell to a seven-week low on Thursday, while bond yields declined as investors reversed trades that had been fueled by speculation of when the Federal Reserve will start to remove its stimulus.

U.S. stocks pushed higher in a choppy session, lifted by gains in Microsoft and drawing some support from Chinese data showing a surprisingly strong rise in exports and imports in July. The trade data eased fears that a slowdown in the world's second-largest economy would threaten the improving outlook in Europe and the still-fragile U.S. recovery.

Equities on European and other stock markets also gained.

Investors remain focused on gauging when the Fed will start to reduce its $85 billion in monthly asset purchases, which have been a major driver of the rally in equities this year.

While the possibility of a reduction in bond buying would typically push Treasury yields higher, yields fell to their lowest level in a week on Thursday, driven by technical trading in what is typically a time of lower volume in the market.

Ten-year U.S. Treasury notes were up 7/32 in price to yield 2.586 percent. The 10-year yield hit 2.573 percent earlier, the lowest level since July 31, according to Reuters data.

The prospect of the Fed buying fewer bonds by the end of the year has made investors rethink some of the trades that were built around the lower rates and excess liquidity that resulted from the program.

Although most analysts expect the dollar will resume gains toward the end of the year, uncertainty about when the Fed may act kept the currency under pressure as investors unwound some cross-asset trades. Fewer participants in the market as the summer winds down also exacerbated moves.

Substantial selling in the bond market has ebbed since the U.S. government reported July jobs data that fell short of expectations. Prices have risen and yields, which move inversely to price, have climbed as some funds cover short trades that generally involved buying Japanese stocks and shorting the yen and the Treasury market.

"We expect that as the Fed moves toward tapering, with September our base case ... the dollar will retrace some of this lost ground and most currencies will weaken into year-end," said Camilla Sutton, chief currency strategist at Scotiabank in Toronto.

Some Fed policymakers suggested this week that the U.S. central bank could scale back on bond purchases as soon as September. But a reduction will depend on continued improvement in the jobs market.

The dollar languished at seven-week lows against other major currencies, with the dollar index dropping 0.3 percent, while the euro rose 0.4 percent to $1.3385.

"To us the price action today smells a bit like final capitulation in poor summer liquidity, as there are few obvious catalysts for the move," wrote analysts at Nomura.

Stocks on Wall Street ended higher, breaking three days of declines as tech stocks, including large cap Microsoft, led the way up.

The Dow Jones industrial average gained 27.65 points, or 0.18 percent, to 15,498.32. The Standard & Poor's 500 Index added 6.57 points, or 0.39 percent, to 1,697.48. The Nasdaq Composite Index rose 15.12 points, or 0.41 percent, to 3,669.12.

"There definitely seems to be some big runners. Microsoft was up quite a bit," said Peter Jankovskis, co-chief investment officer at OakBrook Investments LLC in Lisle, Illinois.

"It could be people decided there are some bargains out there. It's kind of odd that we had a fair amount of this tapering talk the past few days, so I'm surprised in that regard that people have decided to step back in."

European shares on the FTSEurofirst 300 closed up 0.4 percent as Chinese trade data lifted mining shares. MSCI's world equity index rose 0.5 percent.

Data showed the number of Americans filing new claims for jobless benefits rose slightly last week. But the total was still near the lowest level since before the 2007-09 recession.

Oil investors overlooked the Chinese data, sending crude prices lower as traders and funds liquidated long positions. Brent crude fell 76 cents to $106.68 per barrel, while U.S. crude settled down 97 cents to $103.40.

(Additional reporting by Wanfeng Zhou and Chuck Mikolajczak; Editing by Dan Grebler)