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The dollar gained on Tuesday after the Federal Reserve held interest rates steady at 2 percent, opting for the time being to soothe rattled financial markets with central bank lending facilities rather than rate cuts. The dollar was volatile in the moments after the US central bank's announcement as some investors had been hoping for a rate cut as concern about insurer American International Group mounted.
A day after the US stock market suffered its worst decline since the aftermath of the September 11 attacks. Yet as investors debated the Fed decision and the accompanying statement they focused on the positive. The dollar received an added boost against the yen after Bloomberg, citing a person familiar with the matter, reported the Federal Reserve is mulling a loan package to AIG.
"Right now the lack of the Fed to move on interest rates might send a bit of confidence to the markets that things are not as bad as they had thought and that once we clear this AIG problem it will be getting better," said Greg Salvaggio, vice president of trading at Tempus Consulting in Washington.
The euro slipped 0.8 percent to $1.4153, in late New York trading on Tuesday, well off Monday's session peak at $1.4479. The dollar index on the ICE Futures Exchange rose 0.8 percent to 79.109. The dollar rebounded from near four-month lows against the yen, rising to 106.24, up 1.6 percent on the session, the best day since April 1. Earlier in the session, the dollar fell to 103.55, the lowest since late May, according to Reuters data. On Monday, the yen posted its biggest one-day gain versus the dollar in about a decade.
The euro, meanwhile, rose 0.7 percent to 150.40 yen. The US dollar was already in positive territory on Tuesday as nervous investors sought the greenback's safety, fleeing other markets amid global credit worries.
Adding to fears about the US financial system following the collapse of Lehman Brothers, Goldman Sachs, the largest US investment bank, reported a sharp drop in earnings. Goldman's comments also did little to discourage the flight from risky trades, which added to demand for the dollar.
Fearing the fallout from Lehman and capital-raising problems at American International Group, investors clamoured for safe-haven assets such as US government bonds while dumping stocks. Central banks also flooded money markets with cash to encourage banks to overcome credit concerns and lend to one another.
Analysts said that despite much of the bad news originating in the United States, the dollar benefited from the widespread financial jitters as investors, particularly those from the United States, became increasingly keen to send money back home for safety.
"I expect the dollar's upswing to continue. The major driver behind this is a massive repatriation of foreign-based US investments including those from foreign funds," said Adam Fazio, a senior currency strategist, at CIBC World Markets in New York. "When you have a brand new trend that takes hold, like a strong dollar, that trend will pretty much remain in force. Recent corrections in the dollar did little but offer an opportunity to add to dollar longs," he added.

Copyright Reuters, 2008

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