The dollar firmed on Friday as investors sought safety after U.S. budget negotiations to avert spending cuts and tax increases took a turn for the worse, fueling concerns the United States could slide into recession.
The demand for the most liquid currencies, including the dollar and the yen, grew at the expense of growth-linked currencies such as the euro and Australian dollar after a budget plan by the Republican speaker of the House of Representatives,John Boehner, failed to win support from his party.
Boehner, in a news conference on Friday, said it is now up to Obama and his fellow Democrats in Congress to reach a solution to the fiscal cliff.
"While the latest developments have not scuttled the possibility of a broader budget agreement being reached, the timing is now very tight and the margin for error even slimmer," said Nick Bennenbroek, head of currency strategy at Wells Fargo Bank in New York.
"Further U.S. dollar strength and foreign currency weakness is possible with the uncertain backdrop likely to persist for at least the next few days."
Boehner's Plan B, which would have raised taxes only on those earning $1 million or more a year, was rejected by conservative Republicans who adamantly oppose any tax increases.
The dollar index rose 0.50 percent to 79.700. Near-term resistance at the 200-week moving average of around 79.50 was breached as the greenback's rally gathered pace.
The dollar rose significantly against growth-linked currencies such as the Australian and New Zealand dollars. The euro was down 0.51 percent at $1.3174, its worst daily showing in two weeks. Europe's common currency had been in demand in recent sessions on improved sentiment on euro zone assets and earlier optimism on the U.S. fiscal cliff.
The dollar, meanwhile, lagged the yen, as investors trimmed large short positions against the Japanese currency after the Bank of Japan this week increased its asset purchase program by less than some had expected.
Both the dollar and the yen, the most liquid currencies, are likely to be in demand as long as the outcome of the U.S. budget talks remains uncertain. Gains could be exacerbated in thin market conditions before the year's end.
Implied Vols Rise
In the options market, near-term implied volatility rose as uncertainty about the budget talks grew. Demand to hedge against excessive price swings usually rises during times of financial uncertainty.
One-month implied volatility rose to 7.2, from around 6.8 earlier this week. The rise reflected a jump in the volatility index for European stocks as investors sought to hedge against sharp corrections in shares. Traders also reported demand for dollar/yen implied volatility.
One-month dollar/yen volatility rose above 8 vols from around 7 in the middle of the week. Traders pared bets against the yen, which has been pressured in recent weeks by expectations that a new Japanese government will push the Bank of Japan into more forceful monetary easing.