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The dollar hit session highs versus a basket of currencies on Tuesday, while the yen surged broadly as investors concluded US action to save two top mortgage agencies did not alter fundamentals. A souring global growth outlook, that could not be papered over by the US administration taking control of Fannie Mae and Freddie Mac, favoured the dollar and kept its recent rally intact.
The yen's traditional link with stability in uncertain times kicked in as a dose of reality returned to equity markets after an exuberant performance on Monday, sparked by relief over the rescue plan.
"The large chunk of the dollar's rally has been driven by a relative growth shift in the global economy, with the US relatively stable at a soft level while the rest of the world has been going down," Credit Suisse FX strategist Martin McMahon said. "If anything, the fact that the US authorities are prepared to step in adds to the feel that they are doing more to try and stabilise," he added.
The dollar was steady against a basket of six major currency rivals at 79.503, having hit day's highs of 79.776 earlier in the global session near the previous day's one-year high. The euro was flat on the day at $1.4118, near an 11-month low of $1.4049 hit earlier. Another factor adding support to the dollar was oil retreating below $105 a barrel.
The single currency was down half a percent against the yen at 152.08 yen, while the dollar also fell 0.5 percent to 107.72. The yen's resilience also encompassed the Australian dollar and sterling. Yen gains were driven by an unwind of carry trades as global stock markets gave up some gains on Tuesday on the view the US take-over of the mortgage companies has addressed some of the systemic risk stemming from the now year-long credit crisis but had not solved it.
The MSCI measure of world stock markets was down 0.3 percent at 323.80 after registering a 2.3 percent gain the previous day in its biggest one-day percentage gain since March as traders got carried away with relief on the Fannie and Freddie plan.
UBS strategists said while US financial problems were far from over, with the Treasury having been forced into action on the mortgage agencies and unemployment jumping above 6 percent, the dollar's resilience had led it to revise up its forecasts. "We have revised our long term targets for the USD higher across the board as America's economy is likely to come out of recession faster than the rest of the world. We now look for the euro to fall to 1.30 over the next year," UBS said in a note to clients.

Copyright Reuters, 2008

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