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Expect Dollar Gains on Diverging Fed Policy

NEW YORK ( TheStreet) -- The dollar has been under pressure this month against both the yen and the euro, as monetary policy meetings have failed to produce suggestions of additional stimulus in Japan or Europe.

The latest example of this was seen with this week's Bank of Japan interest rate decision, where voting members chose not to extend maturities on bank loans or to make alterations to the bank's annual plans to inject 60 trillion yen ($610 billion) into Japan's monetary base.

The yen rallied after the meeting, as a cross section of the market was expecting the central bank to enact measures to reduce volatility in Japanese bonds.

Moves like this in the yen are likely to occur any time markets perceive the Bank of Japan as being unable to reign in bond yields or ineffective in implementing a sustainable strategy to drive economic growth.

The yield on the 10-year Japanese government bond had risen from its all-time low of 0.315% to 1% after the Bank of Japan announced its historic stimulus program (which doubled monthly bond purchases).

But at the June meeting, a more conservative bias was voiced, and the lack of additional policy easing has led to extreme selling pressure in the Nikkei 225 and rallies in the yen (to more than 94 vs. the dollar). This month's moves have been massive, and valuations are now approaching levels seen when the Bank of Japan's stimulus programs were originally announced.

Diverging Central Bank Policies

Similar results were seen at the latest policy meeting at the European Central Bank, as interest rates were left unchanged at 0.5%. The market's reaction was to push the euro higher, based largely on the suggestion that the ECB sees no immediate need to implement negative deposit rates.

Buying in currency pairs such as the EUR/USD added to the downward pressure on the dollar, helping define this month's broader theme to sell the U.S. currency.

So, the main question investors should be asking is whether these moves are sustainable. Both the Bank of Japan and European Central Bank are in relatively early phases of their current stimulus programs when compared with the Federal Reserve.
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