FOREX-Disarray in U.S. budget talks sends greenback higher

Fri Dec 21, 2012 3:48pm EST

Related Topics

* "Fiscal cliff" uncertainty dents growth-linked currencies
    * Republicans spurn Boehner's Plan B on budget
    * Thin year-end markets may exacerbate currency moves


    By Daniel Bases and Gertrude Chavez-Dreyfuss
    NEW YORK, Dec 21 (Reuters) - Investors turned to the
relative safety of the U.S. dollar on Friday even though
Washington's struggle to come up with a negotiated budget that
averts spending cuts and tax increases took a turn for the
worse, and increased chances of a recession.
    Markets fell beginning late on Thursday when the budget plan
proposed by the Republican Speaker of the U.S. House of
Representatives, John Boehner, failed to win support from his
own party, increasing the chances the austerity measures kick in
and pull the country over the so-called fiscal cliff.
    The breakdown in talks creates the perverse circumstance in
the currency markets whereby the historical safe haven greenback
is boosted over currencies for which economic growth is the key
driver, such as the euro and Australian dollar.
    "Ranges have been pretty tight and most of what happened
overnight continues to dominate through the thin holiday
conditions," said Brian Daingerfield, currency strategist at
Royal Bank of Scotland in Stamford, Connecticut.
    "Despite the stronger than expected U.S. data, we have seen
that risk appetite has not been able to rally back and that can
be attributed to the overhang of the fiscal cliff," he said.
    In a news conference on Friday, Boehner said it is now up to
U.S. President Barack Obama and his fellow Democrats in Congress
to reach a solution before year end. 
    Boehner's Plan B, which would have raised taxes only on
those earning $1 million or more a year, was rejected by
conservative Republicans who adamantly oppose any tax increases.
    The dollar index rose 0.45 percent to 79.616.
Near-term resistance at the 200-week moving average of around
79.50 was breached as the greenback's rally gathered pace. The
dollar rose significantly against growth-linked currencies such
as the Australian and New Zealand dollars.
    "While the latest developments have not scuttled the
possibility of a broader budget agreement being reached, the
timing is now very tight and the margin for error even slimmer,"
said Nick Bennenbroek, head of currency strategy at Wells Fargo
Bank in New York.
    "Further U.S. dollar strength and foreign currency weakness
is possible with the uncertain backdrop likely to persist for at
least the next few days."
    The euro was down 0.5 percent at $1.3172, its worst
daily showing in two weeks. Europe's common currency had been in
demand in recent sessions on improved sentiment on euro zone
assets and earlier optimism a U.S. budget plan could be reached.
    The dollar, meanwhile, lagged the yen, as investors trimmed
large short positions against the Japanese currency after the
Bank of Japan this week increased its asset purchase program by
less than some had expected.
    The dollar was down 0.2 percent at 84.20 yen, below
its recent 20-month high of 84.62 yen. The yen also rose against
the euro, with the single currency down 0.7 percent at 110.95
yen.  
    Both the dollar and the yen, the most liquid currencies, are
likely to be in demand as long as the outcome of the U.S. budget
talks remains uncertain. Thin market conditions before the
year's end could exacerbate price movements.
        
    IMPLIED VOLS RISE
    The Australian dollar traded at its lowest level
since Dec. 3, US$1.0394, in afternoon New York trade, down 0.82
percent. The New Zealand dollar dropped 1.2 percent.
    In the options market, near-term implied volatility rose as
uncertainty about the budget talks grew. Demand to hedge against
excessive price swings usually rises during times of financial
uncertainty. 
    One-month implied volatility rose to 7.3, from
around 6.8 earlier this week. The rise reflected a jump in the
volatility index for European stocks as investors sought
to hedge against sharp corrections in share prices. 
    Traders also reported demand for dollar/yen implied
volatilities. One-month dollar/yen volatility rose
above 8 vols from around 7 in the middle of the week.
    Traders pared bets against the yen, which has been pressured
in recent weeks by expectations that a new Japanese government
will push the Bank of Japan into more forceful monetary easing.
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