TOKYO (Reuters) - The dollar hovered near a three-year low against a basket of currencies on Friday, undermined by the specter of low U.S. interest rates and the crushing weight of the U.S. budget deficit, with some players looking for it to test an all-time low when players return from the Easter holidays.
The dollar index .DXY slipped to a three-year low of 73.735 on Thursday, having slipped below its 2009 trough of 74.170. It last stood at 74.061 on Friday, about 4.7 percent above its record low of 70.698 marked in March 2008.
Trade was thin as many markets were shut for Easter. But some participants said the greenback’s downtrend looked set to resume once players come back from the holidays.
“The market was generally positive on risk, with VIX (market volatility index) falling to a new low since the Lehman shock, so that’s helping to push down the dollar,” said Koji Fukaya, chief strategist at Credit Suisse.
Some market players also said there is a perception that U.S. economic recovery could sputter if the White House and Congress agree to reduce the deficit with significant spending cuts or tax hikes, which would likely force the Federal Reserve to hold interest rates at record lows even as other central banks raise them.
The dollar’s slide accelerated days after Standard & Poor’s slapped a negative outlook on the United States’ top AAA credit rating earlier this week. The agency said a downgrade was possible if authorities can’t slash the massive U.S. budget deficit within two years.
“Although the market’s initial reaction to the S&P announcement was muted, its impact is filtering through slowly,” said Daisuke Uno, chief strategist at Sumitomo Mitsui Banking Corp.
“The biggest reason behind the dollar’s fall is waning investor confidence in U.S. assets. The market is waking up to the fact that fiscal problems are not limited to euro zone periphery countries.”
The euro fetched $1.4575, after hitting a 16-month high of $1.4649 on Thursday.
Putting a brake on the euro’s rally for now were option barriers at $1.4650. Comments from European Central Bank Governor Jean-Claude Trichet that this month’s rate increase would not necessarily be the first in a series and that there were no significant signs of second-round inflationary effects also prompted profit-taking in the currency.
While the euro and other risk currencies are riding high, some investors are starting to worry about a potential setback and trying to protect their long positions by selling put options, said a trader at a European bank.
“They hold long positions in cash, but they are also selling options to guard against black swan events,” the trader said. Such flows are helping to push up euro/dollar implied volatilities in recent days, with one-month volatility rising to around 11 percent from around 9 percent in early April.
Dollar/yen traded at 81.84 yen, near a three-week low of 81.61 yen hit on Thursday.
It has broken below key support around 82.00 yen, a 38.2 percent retracement of its rise from a record low hit in mid-March of 76.25 yen to a six-month high of 85.53 yen in early April.
Its next major support level is seen around 80.90 yen, a 50 percent retracement of the same rally.
“When it comes to the dollar/yen, I see limited downside risks. Clearly there’s stronger fear about intervention after the earthquake than before. Even though it’s not clear whether Japan and G7 will intervene again, the fact that they carried out joint intervention last month means a lot,” said Teppei Ino, currency analyst at Bank of Tokyo-Mitsubishi UFJ.
The dollar also fell to a record low of 0.8782 Swiss franc on Thursday before settling down at around 0.8862 franc on Friday.
Reporting by Hideyuki Sano; Editing by Joseph Radford and Chris Gallagher