The dollar stuck near a six-week high against a basket of currencies on Tuesday on a sharp pullback in global risk appetite as the sovereign debt storm intensified on both sides of the Atlantic. Severe dollar funding strains supported the US currency as European banks scramble to secure cash dollars, with the dollar money market seizing up and investors fearing that a fall in eurozone government bond prices could pummel European banks.
Commodity currencies such as the Australian dollar bore the brunt of the market's fears, though they recouped some of their heavy losses, while the euro escaped with only modest losses as bears stayed cautious given the already huge bets made against the currency.
"There is no fundamental change in the markets' risk averse mood. There's been no clear progress in the eurozone," said Koji Fukaya, chief FX strategist at Credit Suisse. The dollar index held steady in Asia at 78.34, near a six-week high of 78.516 hit overnight, as European and US stocks skidded and funds fled to Treasuries.
The one-year dollar/yen currency swap spread rose to a new peak of 77 basis points, surpassing the previous record hit in 2008, while the three-month euro/dollar swap spread rose to 140 basis points, the highest level since late 2008. In a similar sign, the discount for dollar/yen forwards and the premium for euro/dollar forwards kept rising as well. "Everything is reminiscent of the days after the collapse of Lehman Brothers," said a trader at a Japanese bank.
The dollar hardly budged after ratings firm Fitch repeated that a failure by a US congressional committee to reach agreement on the country's deficit would likely result in a negative rating action - most likely a revision of the rating outlook to Negative, rather than a downgrade.
In the eye of the storm, the euro held up remarkably well at $1.3487, above a six-week low of $1.3421 hit last week, helped by speculation of more short-covering in the currency. The dollar briefly rose to as high as 77.35 yen but quickly ceded gains to stay around 77.09 yen. The Australian dollar pared some of its heavy losses incurred on Monday to stand at $0.9847, up 0.1 percent on the day but still below a support-turned-resistance level of around $0.9910, a 61.8 percent retracement of the October rally. The next downside target is seen at $0.9710, a 76.4 percent retracement level.