* Dollar soft as Fed tightening expectations subside for now
* Traders see rebalancing dollar sales after big Q1 gains
* Investors still see potential rise in inflation worries
* Graphic: World FX rates https://tmsnrt.rs/2RBWI5E
By Hideyuki Sano
TOKYO, April 7 (Reuters) - The dollar softened to a two-week
low against a basket of currencies on Wednesday after U.S. bond
yields declined as traders rolled back aggressive expectations
that the Federal Reserve will tighten its policy earlier than
pledged.
The dollar index hit a two-week low of 92.246 =USD ,
slipping further from a five-month high of 93.439 set on March
31, and last stood at 92.343.
"Following the dollar's strong gains last quarter, some
investors appeared to have over-allocation in dollar assets and
they probably need to sell dollars for rebalancing," said
Kazushige Kaida, head of FX Sales at State Street Bank's Tokyo
branch.
The previous quarter saw the dollar's strongest rally in
years on rising expectations that accelerating U.S. economic
growth and inflation could force the Fed to abandon its pledge
to keep interest rates near zero until 2024.
The dollar index rose 3.6% in the quarter, its biggest
quarterly rise in three years. Against the yen, the U.S.
currency rose 7.2%, the largest since the last quarter of 2016.
As some bullish bets on the dollar were unwound this week,
the euro rallied to a two-week high of $1.18785 EUR= and last
stood at $1.1867.
Similarly, the common currency jumped almost a pence against
the British pound overnight to trade at 85.90 pence EURGBP=D4 ,
its biggest gain since Dec. 10, in a reversal from the pound's
steady gains during the last quarter.
The dollar was on the defensive at 109.77 yen JPY= ,
extending its retreat from a one-year high of 110.97 touched a
week ago.
The dollar is nearing a critical juncture to maintain its
long-term uptrend, said Osamu Takashima, chief currency
strategist at Citigroup Global Markets Japan, noting a break
below a key support level from its 21-day moving average, at
109.40 now, could herald a bearish turn.
Another key technical indicator, the 14-day relative
strength index (RSI), is already flashing a warning sign,
falling below its previous bottom of 66 to 62, he said.
Traders were recalibrating their expectations on the Fed for
now after U.S. interest rates futures earlier this week had
priced in a 0.25 percentage point rate hike by the end of 2022.
The five-year U.S. Treasury yields dropped sharply to 0.874%
US5TY=TWEB after hitting a 14-month high of 0.988% on Monday.
Yet many investors think the jury is still out on whether
the Fed can stick to its dovish stance.
"Vaccines are now helping to boost U.S. economic activities,
while we also have largesse from the government spending and
easy money from the central bank... So while the Fed says it is
not worried about inflation, markets still are. The risk for
interest rates is still on the upside," State Street's Kaida.
Elsewhere, the Australian dollar held firm near a two-week
high against the dollar at $0.7652 AUD=D4 while the British
pound slipped to $1.3824 GBP=D4 from Tuesday's two-week high
of $1.3910.
Bitcoin was flat at $57,872 BTC=BTSP .
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