The dollar staged a rebound against major currencies on Tuesday as traders pared short positions on looming uncertainty over whether the U.S. Federal Reserve will start a new phase of quantitative easing to deal with a slowing economy.
Much uncertainty surrounds the Federal Reserve's policy meeting on Tuesday with the market deeply divided over what the Fed might do, beyond a rough agreement that it will sound more cautious on the recovery.
I have a feeling that the market has got carried away with the idea of the Fed easing. It seems as if most traders are expecting the Fed to say it will reinvest maturing bonds at least, said a trader at a Japanese bank.
A Ried Thunberg/ICAP poll of money managers found that 52 percent thought the Fed would take no new action on policy, while 48 percent believed they would at least hint at new steps.
Such steps may include anything from a promise to consider more quantitative easing; to reinvesting money from maturing debt into Treasuries or MBS; to cutting interest paid on excess reserves; to buying financial assets outright.
If the Fed does take action today and U.S. interest rates fall, that is likely to lead to dollar-selling, said Hiroshi Maeba, manager of forex at Nomura Securities.
The crucial policy announcement from the Fed is expected around 1815 GMT.
Given the uncertainty, speculators chose to trim their short U.S. dollar positions, pulling the euro back to $1.3186, down 0.25 percent from $1.3225 in New York and a three-month peak of $1.3334 on Friday.
Its decline mounted after stop-loss orders hit at $1.32.
The pullback came despite upbeat euro zone data, with investor morale surging and German exports up strongly.
German exports have benefited greatly from resilient demand in Asia, which should be echoed by July trade data from China on Tuesday. China's exports are seen up 35.5 percent on the year, with imports rising 30 percent.
The yen was the exception to the dollar's broad rebound on Tuesday, edging up slightly, due to repatriation by Japanese investors due to the redemption of U.S. bonds.
The Bank of Japan will also conclude its two-day policy meeting on Tuesday, although most market players do not expect the Japanese central bank to take action this time.
But some traders think a lack of action from the BOJ could push the yen higher, especially if the Fed does embark on new steps.
The dollar slipped to around 85.80 yen, down 0.1 percent, though it's still some distance from last Friday's eight-month low of 85.02 yen.
Still, there were substantial stop-loss orders just under option barriers at 85 yen, potentially triggering a further slide, traders said.
More stops were sitting below 84.82 yen, with option barriers at 84.75 yen seen rolling off later in the week.
Traders think the yen will eventually test these levels as Japan is unlikely to intervene to curb the yen unless dollar/yen falls to around 80 yen.
Japanese Finance Minister Yoshihiko Noda declined to comment on intervention. He also said the recent market moves are somewhat onesided, but that produced no market response.
The pound slipped 0.5 percent to $1.5824 after data showed British house prices fell last month and retail sales growth slowed abruptly.
The Australian dollar also dropped 0.4 percent to $0.9126 after National Australian Bank's monthly business condition survey showed business confidence dropped to its lowest in 14 months.
(Additional reporting by Wayne Cole in Sydney; Editing by Joseph Radford)