Most investors expect a debt deal will be done before the Aug. 2 deadline to avert default, but the lack of progress in talks over how to cut the US budget deficit and the possibility that ratings agencies may downgrade the nation's debt weighed on risk sentiment.

The US Treasury says it will run out of money to pay the country's bills after Aug. 2, though some analysts say the Treasury may be able to scrape some money together to get by for a week or two -- a scenario that some market players are starting to think cannot be ruled out.

The dollar shed nearly 2 percent on the day against the Swiss franc to hit an all-time low of 0.8029 franc on trading platform EBS. The franc also rose sharply against the euro.

"The US will have to come up with credible long-term plan in order to avert a downgrade," said Manuel Oliveri, currency strategist at UBS in Zurich.

"The increasing risk of a downgrade means declining confidence in US assets and the risk of capital outflows, which is a negative for the dollar against the Swiss franc and the yen," he added.

The dollar slipped to a four-month low of 78.05 yen in European trade, with traders reporting selling from Asian sovereign accounts.

Many traders think the dollar could test a record low of 76.25 yen if the US debt crisis drags on.

The greenback was close to a six-week low hit against a basket of currencies last week of 73.889.

"Below 74 in the dollar index could see it potentially down towards the record lows (around 70.70) hit in 2008," said Kathleen Brooks, head of research strategy at FOREX.com.

"If US GDP data on Friday shows weak growth added to an unsustainable debt burden, that has to be toxic for the dollar," she added.

SWISS FRANC SHINES

The euro initially slipped against the dollar after Moody's downgraded Greece by three notches to Ca from Caa1, though the impact was limited because the move was not a surprise and traders were focussed on the US debt saga.

The euro was last up 0.3 percent against the struggling dollar at $1.4400, but the euro zone's lingering debt risks kept traders wary over the single currency.

The sweeping bailout and policy package agreed by euro zone leaders last week has helped stem market panic in the short run. But analysts say the measures may not be enough to bring the crisis to a swift resolution.

Such uncertainty fuelled further demand for the low-yielding Swiss franc, which many investors see as the cleanest way of playing euro zone and US weakness. The euro was down 1.7 percent at 1.1568 francs, within sight of a recent record low of 1.1365.

"With lingering uncertainty over the sustainability of the euro zone bailout package and concerns over the US debt ceiling, we would expect the franc to continue to gain this week," said Oliveri at UBS.

Copyright Reuters, 2011