The dollar fell to a four-month low against the yen today as investors fled risky positions after US lawmakers refused to pass a $700 billion bank bailout plan, sparking the biggest Wall Street stock sell-off since 1987.
But the dollar quickly recovered ground against the yen, as Asian stock markets trimmed some of their earlier losses.
The US House of Representatives on Monday unexpectedly rejected a plan to buy toxic assets from struggling banks in an effort to revitalise strained lending markets.
The move hit the dollar by dashing hopes for a comprehensive solution to the credit crisis that has claimed a variety of major financial institutions such as Lehman Brothers this month, stirring worries of a deeper economic downturn.
"There are many dollar-selling factors such as a slowing economy, possible Fed rate cuts and an outlook for worsening fiscal conditions for the US government as it is expected to spend money to rescue banks," said Osamu Takashima, chief currency analyst at Bank of Tokyo-Mitsubishi UFJ.
But the euro and sterling have also suffered as banks in Europe succumb to the widening crisis fallout, prompting investors to rush for currencies seen as a safe-haven during the turmoil, such as the yen and Swiss franc.
"The simple way to understand all the developments is that the yen is an alternative choice as a safe haven, with the euro and dollar shunned due to the credit crisis," said a senior trader at a Japanese trust bank.
The rejection by US lawmakers of the bailout package caused panic among investors, with the Dow Jones industrial average suffering its biggest one-day point drop ever.
Asian markets tumbled as well, with Japan's Nikkei average falling nearly 5 per cent at one stage. The Nikkei later recouped some losses and was down 3.7 per cent in late trade.
The dollar struck a four-month low of 103.50 yen on trading platform EBS before recovering to 104.45 up 0.4 per cent.
Despite the dollar's recovery, traders expect it to weaken against the yen as risk aversion is expected to spread after trade moves to Europe and the United States.
The dollar is also vulnerable because more investors are betting the Federal Reserve will cut interest rates from the current 2 per cent in an effort to limit the economic fallout from the worst financial crisis since the Great Depression.
The dollar fell 4.3 per cent against the yen during September, when problems in the US financial sector went from bad to worse.
Earlier this month, the US government took control of troubled mortgage finance giants Fannie Mae and Freddie Mac and bailed out insurer AIG while Lehman Brothers filed for bankruptcy.
The euro fell 0.2 per cent to $1.4391 after falling to a low of $1.4338 earlier today. The single currency was 2.2 per cent below where it was at the end of August.
Reuters