The dollar dropped against the euro and the yen on Monday as the latest developments in the Greek debt crisis ratcheted up uncertainty in the financial markets and fueled doubts that the Federal Reserve would increase U.S. interest rates this year.
Currencies swung as increased tensions between the Greek government and its international creditors over the weekend rattled markets and called into question Greece's place in the eurozone and the very integrity of the common currency itself. The gyrations sent investors into the yen, an asset investors generally regard as one that retains its value amid bouts of economic or political uncertainty.
The euro recovered from a selloff during the Asian session that had plunged it to a three-week low against the dollar. By late afternoon in New York the euro traded 0.7% higher at $1.1236, its highest in a week. Against the yen, the dollar slid 1.1% to 122.53 yen, heading for its weakest New York close since May 25.
Monday's moves continue to highlight the degree to which investors have struggled to interpret how risks would play out in the currency markets, particularly the growing uncertainty surrounding when the Fed would raise borrowing costs and whether Greece's substantial debts would ultimately push it out from the eurozone and upend financial markets.
"The Fed could hold off [on raising interest rates] if the Greek contagion spreads wider than people thought, or if the dollar strengthens too much," said Wasif Latif, head of global multi-assets at USAA Investments, with $68 billion in mutual fund assets.
Other forces propelled the euro higher on Monday, surprising investors who expected the currency to weaken. Investors outside Europe continued to exit positions in eurozone equities and buy back euros they had previously sold to shield their stock picks from adverse currency moves, said David Woo, head of global rates and currencies research at Bank of America Merrill Lynch.
"If European stock markets go down, investors don't want to be overhedged and don't want the currency risk," Mr. Woo said. "The markets have been seeing a negative relationship between European equities and the euro for a while. I'm not certain of the direction of causality between these two things, but this is clearly a factor."
In addition, investors continued to close out those bets that involve borrowing the low-yielding euro and selling it to fund trades for riskier, higher-yielding emerging-market currencies. Exiting the popular trades involves purchasing the euro, investors say.
Those factors have lifted the euro against the dollar over the past couple of months, as negotiations between Greece and its creditors--the European Central Bank, the European Commission and the International Monetary Fund--have failed to advance toward a deal that would help the beleaguered country repay its debts.
Over the weekend, the standoff between Greece and its creditors reached a new stage. While eurozone finance ministers turned down requests to extend the country's bailout, the Greek government called for a referendum on whether to accept austerity measures demanded by the country's creditors in exchange for further aid.
The government also closed Greek banks for six days, while the country's central bank imposed controls to keep money from leaving the country.
Still, investors were hopeful the central bank would step in to keep the effects of the crisis from spreading and provide liquidity if necessary to keep the monetary union from breaking apart.
"The ECB has firepower and will to keep euro from breaking apart," said Josh Feinman, chief global economist at Deutsche Asset and Wealth Management, which oversees $1.25 trillion. "They'd step in guns blazing if this appears to start falling apart. The market is taking reassurance from this."
The asset manager has bets that the euro will weaken against the dollar over the next year and is betting that Greeks will vote "yes" in the referendum, Mr. Feinman said, moving it back on a path to an agreement with its creditors.
But investors also believe this turn in the Greek crisis will create too much instability in the financial markets, causing the Fed to approach monetary policy with more caution. Some are pushing back expectations from September into December, and even into 2016.
Investors had rushed into the dollar earlier this year in anticipation of higher borrowing costs in the U.S., sending it soaring to multiyear highs against rival currencies. The dollar's rally halted after soft U.S. economic data during the first three months of 2015 raised doubts in the market that the Fed would tighten monetary policy.
Any signs that the Fed will postpone raising interest rates for the first time in nine years will hurt the dollar. Higher U.S. rates make the dollar more attractive to investors.
Write to James Ramage at james.ramage@wsj.com
(END) Dow Jones Newswires
June 29, 2015 17:12 ET (21:12 GMT)
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