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NEW YORK (Reuters) - The dollar slipped on Monday and the yen gained on safe-haven demand, as U.S. lawmakers struggled to reach a deal before this week's debt ceiling deadline, stoking concerns the United States may actually default on its debt obligations.
While negotiations in the U.S. Senate to bring the fiscal crisis to an end showed signs of progress on Sunday, failure to break the stalemate before Thursday, the deadline to raise the debt ceiling, would leave the world's biggest economy unable to pay its bills in the coming weeks.
"The seemingly once-dismissed threat of a U.S. default is very much alive," said Christopher Vecchio, currency analyst, at FXCM-owned DailyFX.com in New York. "The re-introduced tension has the Japanese yen reviving its role as safe-haven du jour," hurting the dollar as well.
In late trading, the dollar was down 0.1 percent against a basket of currencies .DXY at 80.289.
The dollar slipped 0.1 percent versus the yen to 98.44 yen, having touched a low of about 98.05 yen earlier. The dollar retreated from a near two-week high of 98.60 yen set on Friday.
The yen's liquidity makes it a relatively safe option during times of uncertainty. Traders said bids for the U.S. dollar at levels near 98.00 yen helped to limit the yen's rise.
The dollar was down 0.3 percent against the Swiss franc at 0.9099 franc, while the euro was up 0.2 percent at $1.3569.
Investors may be wary of betting too heavily in one direction, given the possibility of a last-minute deal which could make the dollar rally, analysts said.
With currencies trading in tight ranges, volatility has taken a hit. One-month euro/dollar volatility slipped on Monday, near lows last seen in mid-September when the Federal Reserve surprised markets by refraining from trimming its stimulus, pushing vols to a six-year trough.
Many in the market, however, expect the political gridlock to end just before the October 17 deadline.
"Investors..don't believe that the U.S. government will allow for its first ever default and this assumption is helping the markets maintain a level of stability," said Kathy Lien, managing director at BK Asset Management in New York.
"However, the risk premium is high and for this reason, we don't expect any new positioning or breakout trends until the uncertainty is lifted."
Market holidays in Japan and partial market closure in the United States on Monday added to the subdued mood. Trading in euro/dollar was the lowest since April 1, using Reuters Dealing data, and May 6 for dollar/yen.
Economists said fiscal worries would support the Fed's decision to maintain its stimulus, or quantitaive easing.
But Lena Komileva, managing director at G+Economics in London, said quantitative easing is no cure for political risk or government paralysis and job losses.
"The longer QE continues the greater the markets' dependency becomes and...the greater the risk of market...volatility when the Fed launches tapering eventually."
Additional reporting by Nick Olivari