The dollar fell to a four-month low against the yen and hovered near record lows versus the Swiss franc today, while the euro came under fresh pressure as investors sought safe havens on mounting US and euro zone debt problems.
US authorities appeared as far away as ever from reaching a cross-party compromise to raise the debt ceiling and Moody's said it may cut Spain's credit rating. This is likely to keep growth-linked currencies, including the Australian and New Zealand dollars subdued.
Urgent efforts to avoid an unprecedented US default hit another snag when conservative Republican lawmakers refused to back a deficit reduction plan proposed by their own leaders, who put off a vote scheduled for last night.
The dollar was down 0.1 per cent against the yen at 77.65 yen, having fallen to a four-month low of 77.448 on trading platform EBS. Japanese finance minister Yoshihiko Noda issued a strong warning about the strong yen, saying he would carefully consider how long Tokyo could ignore current exchange-rate moves without acting.
Expectations of possible intervention and position-squaring ahead of the weekend prevented a further rise in the yen. The dollar found support around 77.50 yen, with traders citing semi-official bids.
"These sovereign debt problems are leading to a decent demand for safe-haven currencies like the yen and the Swiss franc," said Roberto Mialich, FX strategist at Unicredit.
"How the dollar behaves in the near term will depend a lot on how the credit rating agencies react and whether the US rating is cut."
Analysts say that even if a last-minute deal to lift the debt limit is struck before the August 2nd deadline, a US rating downgrade appears likely without a comprehensive plan to cut the deficit. A cut would raise US borrowing costs, hurting an already weak economy, and rattle investors.
Many traders expect a sharp fall in the dollar would trigger heavy selling by Japanese margin traders who hold near-record high long dollar positions, aggravating its decline.
In the options market, implied volatilities climbed. One-month vols traded around 10.95 per cent, up from 10.6 per cent yesterday. Dollar/yen risk reversals, a measure of the premium required to hold a put or a call option in a currency pair, also edged out in favour of yen calls with the one-month at 1.9 vols versus 1.8 yesterday.
"Risk reversals are very, very high. That tells me the market is clearly set up for the downside," said Simon Smollett, options strategist at Credit Agricole.
Debt problems also hit the euro. In a reminder that risks of contagion from the euro zone's sovereign debt crisis was far from gone, Moody's placed Spain's Aa2 credit rating under review for a possible downgrade, citing funding pressures and the precedent set by the region's second rescue package for Greece.
Spanish and Italian bond yields rose while the euro was last down 0.3 per cent at $1.4290. It got some support from a Greek finance ministry official who said China could provide loans to Greece to fund government bond buy-backs.
"The euro has decent support at $1.4250, but if that level gives way, we could see it fall all the way down to $1.4150," said Unicredit's Mialich. The euro fell to a low of $1.4253 yesterday. With investors less willing to take on risk due to the euro zone and US debt problems, the recently outperforming Australian and New Zealand dollars fell prey to profit-taking.
Both currencies, which this week hit multi-year highs, hovered near session lows with the Aussie trading down at $1.0940 and the kiwi 0.6 per cent lower at $0.8655.
The sell-off in the euro and growth-linked currencies supported the Swiss franc. The euro was down 0.4 per cent against the franc at 1.1444 francs while the dollar was flat at 0.8010 francs, not far an all-time low of 0.7990 francs.
Reuters
