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US dollar dozes, saves its strength for New Year

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The US dollar was dozing at 117.55 yen after reaching 118.66 yen a week ago, its strongest since early February.

[SYDNEY] It was hard to find a pulse in the currency market on Friday as dealers bedded down for the Christmas holidays, though the mood remains bullish for more US dollar gains in the New Year as yield spreads widen in its favour.

The US dollar was dozing at 117.55 yen after reaching 118.66 yen a week ago, its strongest since early February.

The single currency was a shade firmer at US$1.0434, having rebounded only modestly from a nearly 14-year low of US$1.0350 set on Tuesday.

The US dollar index was marginally higher at 103.05 and within striking distance of the week's 103.65 peak.

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Data out on Thursday had shown US economic growth was quicker than initially forecasted in the third quarter, but disappointing numbers on personal spending and income pointed to a slowdown in the present quarter.

The US dollar rally has been fuelled in part by bets that the incoming Trump Administration and a Republican-controlled Congress would slash taxes and boost debt-funded spending, pushing up inflation and bond yields.

Currently two-year US paper offers a plump premium of 198 basis points over German debt, up from 144 at the start of November and near the widest since 2005.

"Yields spreads should attract more capital into the USD," said Ray Attrill, global co-head of FX at NAB. "Monetary policy divergence is set to be more pronounced in 2017 with Fed tightening while BoJ, ECB and BoE further expand their balance sheets," he added.

"FOMC risk is skewed to the Fed doing more, not less, than the 60 basis points of tightening currently priced."

Indeed, the Bank of Japan and European Central Bank are actively working to keep their short-term yields deep in negative territory, widening the gap even further.

Yet Mr Attrill also saw reasons why the US dollar might not rise as far as some bulls expect.

He argued the US dollar rally already fully reflected the widening in spreads since Mr Trump's election and a further sharp increase in US yields could start to weigh on stocks and the economy, drawing resistance from the Federal Reserve.

"We aren't expecting 10-year US yields to make a sustained move above 2.75 per cent in 2017. This is more consistent with a 3-5 per cent rise in the USD than 10 per cent."

Elsewhere, traders were keeping an eye on developments in the widely anticipated government-led rescue of Monte dei Paschi di Siena bank with the Italian cabinet meeting to hammer out the details.