US debt battle hits dollar

While US government bond prices rose despite the crisis and a new auction of Treasury bills went off smoothly, spikes in the price of insurance on US debt gave away the growing nervousness in the markets over the political deadlock.

And while foreign stock markets have so far remained relatively immune to the troubles in Washington, US markets sank for a third straight day.

The biggest sign of disquiet over the political deadlock -- which could result in the government running out of money to pay its bills and service debt on August 2 -- was a clear move out of the dollar on currency markets.

At 2200 GMT, the dollar had sagged nearly one per cent against the euro, which traded at $1.4516, compared to $1.4375 a day earlier.

The dollar had dropped sharply late Monday when President Barack Obama took his argument against rival Republicans to the American public, signaling in a prime-time television address that the two sides were still far from agreeing on how to address the country's huge debt and deficit problems.

The dollar meanwhile lost another 0.6 per cent to the safe-haven Swiss franc, dropping to 0.8012 francs, and fell 0.5 per cent against the yen to 77.94 yen.

The pound also pushed up sharply against the greenback, buying $1.6422 against $1.6278 a day earlier.

Gold climbed six dollars to above $1,620 an ounce in New York trade, though it was still below the record of $1,624.07.

US stock markets dropped for a third straight session: the Dow Jones Industrial Average lost 0.7 per cent, the broader S&P 500 shed 0.4 per cent and the tech-heavy Nasdaq Composite slipped 0.1 per cent.

But bond investors sent a contradictory message to politicians, despite the prospect that the rating agencies could downgrade US debt within days because of the impasse.

The yield on the 10-year Treasury fell to 2.95 per cent from 3.00 per cent late on Monday, while the 30-year bond dropped to 4.27 per cent from 4.32 per cent.

And the Treasury easily auctioned off another $24 billion in four-week bills and another $35 billion in two-year notes at good prices for the government.

"The Treasury market just isn't making Washington take the problem seriously," said Sebastien Galy of Societe Generale after the morning's Treasury auction.

"The other side of that coin, is that the US authorities are still using the dollar as the pressure valve for this crisis -- we don't get higher yields, but we do get a weaker currency," he said.

Even so, in the market for credit default swaps, the cost of insurance against default for holders of US bonds spiked: 70 per cent for the one-year bond since the end of last week, and 40 per cent for the 10-year.

Still, the prospect of the US not raising its $14.3 trillion borrowing ceiling before it is forced to default on its debt was only having a limited effect on markets.

Traders said that is because investors believe that eventually the US will raise the debt ceiling and pay its debts, and they have few alternatives to invest in, given the special place the US dollar and Treasury bonds have in global finance.

"I don't think you are going to see this massive followthrough liquidation of US assets, and especially US debts, simply because there is no place else to put the funds," said David Solin of Foreign Exchange Analytics.

"Where are these people going to put their funds?"

Analysts were also saying that the Treasury had more room to move than it admits after August 2.

"It still looks as though they'll have enough cash in August to fund operations into the second week of the month," economist Lou Crandall of Wrightson ICAP said.

"I think (August 2) is put out there as a D-Day, this deadline day, but it's not really," Jeff Cleveland of investment bank Payden & Rygel told NPR radio's Marketplace program Tuesday.

"It's not until you get to that August 15 point where you have to make that payment. That's a large chunk of money."

The White House nevertheless insisted the crunch would hit next Tuesday.

"That's not a guess. That's not a political opinion," said White House spokesman Jay Carney.

"Beyond that date, we lose our capacity to borrow."