The US dollar fell against the euro and yen on Wednesday as the US government's rescue of insurer AIG failed to calm investor concerns about the stability of the US financial sector. American International Group's emergency $85 billion loan from the Federal Reserve was welcomed by investors but with shares of Wall Street giants Morgan Stanley and Goldman Sachs tumbling, investors were not willing to raise their risk tolerance.
The dollar's decline against the euro was exacerbated by thin trading after the euro broke through a key level, forcing some investors who had bet against the single euro zone currency to buy euros to prevent further losses, analysts said.
"There are still a lot of currencies being moved by short term risk factors and just the general market sense of the unknown," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida. "Everyone is afraid and no one wants to put capital at risk in the face of such unprecedented events."
The euro last traded up 1.4 percent at $1, after trading as high and as low as the global session. It was the narrowly the euro's best day against the dollar since March 12, according to Reuters data. .
"We broke some technical levels above $1.4250 that forced a short squeeze," said Brian Dolan, chief currency strategist, at Forex.com in Bedminster, New Jersey. The dollar dropped as low as 104.39 yen at one point, closer to the nearly four-month troughs seen on Tuesday, according to Reuters data. It was last down 1.1 percent at 104.55 yen. "We are still seeing some very nervous markets despite the best efforts that the government has put forward," said Nick Bennenbroek, head of currency strategy at Wells Fargo in New York.
"It looks like there is significant stress in the market in terms of money market spreads still being wider and US equity markets under pressure and during these much volatile periods, it seems to be the yen that's doing the best."
The interbank cost of borrowing three-month dollars posted its biggest daily gain in almost nine years on Wednesday, reflecting high stress in money markets. The ICE Futures US dollar index, which measures the dollar's value against a basket of six currencies, slipped 1.3 percent to 78.154.
"The dollar had benefited from safe-haven capital flows into US Treasuries and we are seeing a little bit of an unwinding of that," said Omer Esiner, a senior currency analyst at Ruesch International in Washington. The US dollar at one point in the global session fell 2 percent against both sterling and the Swiss franc. The dollar fell to session lows against the Swiss franc at 1.0993 francs. It last traded at 1.1024, down 1.8 percent on the day.
Sterling, meanwhile, rose to a session high at $1.8243, and was last at $1.8183, up 1.8 percent against the dollar. Traders were at a loss to explain Wednesday's sharp moves, as correlations have broken down. A US-based trader said the mood in the market right now is just squaring up positions and sticking to the sidelines.