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Dollar weighed down by US default risks

(Reuters) - The U.S. dollar remained under pressure on Tuesday, weighed down by the risk of a U.S. default as a standoff between Democrats and Republicans over raising the debt ceiling showed few signs of being resolved.

The Aussie dollar flipped from early small gains to a loss after economic data from key trading partner China fell short of analysts' forecasts, adding to evidence of a sputtering COVID recovery. The yuan sank toward a two-month low.

The U.S. dollar index - which measures the currency against a basket of six major peers - was little changed at 102.47. Overnight, it retreated from a five-week high to lose 0.26%.

The dollar had been buoyed last week by both safe-haven demand amid weak Chinese economic data and by a surprise jump in U.S. consumer inflation expectations, putting the risk of a June Federal Reserve rate rise back in play.

This week, though, the looming borrowing limit - which Treasury Secretary Janet Yellen reiterated could be hit as soon as June 1 - has forced its way to the front of investors' minds.

President Joe Biden expressed confidence a deal could be done in time ahead of an expected meeting with congressional leaders later on Tuesday. However, Republican House of Representatives Speaker Kevin McCarthy said the two sides were still far apart.

"There's been a bit of complacency in the fact that the market is generally thinking that something will get done, but if you don't prepare for the worst, there could be a lot of pain," said Bart Wakabayashi, a branch manager at State Street (NYSE:STT) in Tokyo.

"The interesting thing is the dollar is weak, and usually when there's risk off, people buy the dollar," he said.

"So there's a big breakdown in correlation, and when correlations don't work, people don't know what to do."

The euro, which has the greatest weight in the dollar index, was little changed at $1.0870 on Tuesday, after bouncing off a five-week low overnight.

Sterling slipped 0.13% to $1.2515, following a 0.67% rally from Monday.

The yen, which had been hit by a wider spread between U.S. and Japanese long-term yields, pulled itself off a nearly two-week low.

The dollar lost 0.08% to 135.975 yen after rising to 136.32 on Monday.

The 10-year Treasury yield eased to around 3.49% in Tokyo from as high as 3.511% overnight.

The Australian dollar, which is not part of the dollar index, erased small early gains ahead of Chinese retail sales and industrial production data, then sank after the release. It was last down 0.33% at $0.6678.

"The Aussie's upside looks to have been capped for some time by investor concerns over China's outlook," said Sean Callow, a senior FX strategist at Westpac.

"Today's data will set the Aussie back on its heels," he added, predicting the currency could ease to around 0.6645, the lower limit of its recent trading range.

The dollar gained 0.2% to 6.9723 yuan in the offshore market, after touching 6.9749 on Monday for the first time since March 10.

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