Dollar gains on post-Fed yield increases

NEW YORK (MarketWatch) � The dollar rose to an 11-month high against the Japanese yen and posted gains versus other currencies on Wednesday as analysts assessed whether the U.S. currency could resume its connection to bond yields instead of stocks.

The move began in the prior session after Treasury yields rose to their highest levels in four months and the U.S. Federal Reserve offered no hints it�s likely to pursue further quantitative easing anytime soon.

The ICE dollar index DXY , which measures the greenback against a basket of six currencies, rose to 80.596 from 80.231 in late North American trading on Tuesday. It touched its highest level since January.

�The U.S. dollar�s inverse relationship with �risk,� although never perfect, may have finally run its course.�

Neil Mellor, currency strategist at Bank of New York Mellon

Against the Japanese currency USDJPY , the dollar rose to its highest level since last April, buying 83.76 yen, compared with �83.03 late Tuesday.

The central bank�s rate-setting Federal Open Market Committee, or FOMC, on Tuesday reiterated that they expect rates to stay low until late 2014. The central bank also made no changes or hints about future changes to its bond-purchase programs.

The move pushed Treasury bond yields out of their recent range and back to levels not seen since October, when the Fed began its current bond-buying program. Read about Treasury yields rising.

That has increased the extra yields investors around the world get over their local government bonds, boosting the appeal of switching into dollars to buy U.S. assets, analysts said. Up until the U.S. credit crisis, those interest-rate differentials were the main driver of currency markets. Since then, the dollar has mostly reacted to trader�s appetite for risk: falling when riskier assets look more appealing and gaining when safe havens were in demand.

�A big part of the story behind recent dollar strength is the noticeable shift in interest-rate differentials,� said Marc Chandler, global head of currency strategy at Brown Brothers Harriman.

U.S. 2-year note yields 2_YEAR �rose to 0.39%, their highest since July.

That was the highest gap over Japan�s 2-year debt, which yields 0.10%, since last July, according to Chandler.

With German 2-year debt yielding 0.25%, U.S. yields also reached their biggest spread over those securities since June 2010, he said.

�The U.S. dollar�s inverse relationship with �risk,� although never perfect, may have finally run its course,� said Neil Mellor, currency strategist at Bank of New York Mellon.

The dollar rose even as U.S. equities struggled to advance on Wednesday. See story on U.S. stocks.

Rising U.S. yields also makes the dollar less attractive as a currency to borrow in to buy higher yielding assets, known as carry trades. The yen has long been the premier carry trade because of its continuously low, stable rates.

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�With [Fed Chairman Ben] Bernanke�s implicit nod to a less weak economy and the markets reaction to push yields higher, this lifts the dollar from the funding table and signals that the euro-dollar can depreciate,� said Lauren Rosborough, a currency analyst at Societe Generale.

The euro EURUSD �slipped to $1.3022, versus $1.3065 in late trading Tuesday.

The British pound GBPUSD �turned down to $1.5672, from $1.5693.

Solid gains by European equities and a well-received auction of Italian government bonds helped lift the shared currency as risk appetite increased across the board, said Geoffrey Yu, strategist at UBS.

That�s still weighed on the Japanese yen because of the Bank of Japan�s recent decision to further loosen monetary policy.

Looser BOJ policy �is, at last, weakening the yen. And with the [Swiss National Bank] successfully capping the Swiss franc, we see one safe-haven currency left: the U.S. dollar,� he said.