Dollar Bruised by Fannie, Freddie, Oil Surge

The dollar slumped Friday, battered by heightened worries about the U.S. financial sector after a report said the U.S. government is considering taking over mortgage agencies Fannie Mae and Freddie Mac if their situation worsens.

Comments by U.S. Treasury Secretary Henry Paulson in response to the news failed to soothe jittery financial markets, and, in some views, exacerbated fears that the two lenders are in trouble.

Paulson said Friday his aim at present is to back government-sponsored mortgage buyers Fannieand Freddie in their "current form," offering no indication that the government intends to step in and support the two lenders.

"(This is) not the type of thing that the markets would react strongly to," said Michael Woolfolk, senior currency strategist at Bank of New York Mellon in New York.

"It is designed more to signal policy intent than manage market expectations. He left his cheer-leading outfit in the drawer." Following Paulson's statement, the euro rose to $1.5947, the highest since April 23, according to Reuters Dealing. It fell slightly, to around $1.58.

It traded up versus the dollar

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[EUR-TN  Loading...      ()] on the day, for the biggest one-day rise since June 6.

The New York Board of Trade's dollar index also fell to a 2-1/2-month low at 71.795, posting its largest daily fall in more than a month. Against the yen,

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[JPY-TN  Loading...      ()] the dollar dropped.

Analysts said the dollar is trading at such perilous levels that it could spur government intervention to support it.

"There's concern that the FX market is starting to look disorderly, which means the possibility of intervention is creeping up a bit," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.

"For now, though, I think it's still a relatively low probability because it's incompatible with expectations of more ECB hikes. But if the euro cracks above $1.5950, I think we could see $1.60," he added.

Despite the global financial turmoil, the European Central Bank has left options open to raise interest rates again this year to quell rising inflation.

Record Oil Prices

A report in the New York Times on a possible take-over of Fannie and Freddie initially boosted the dollar on investor views that government action on the two entities could finally mark the bottom for the troubled financial sector. But that optimism was short-lived.

"Clearly, the dollar is not reacting positively to the Fannie and Freddie news at this point," said Vassili Serebriakov, a currency strategist, at Wells Fargo in New York.

"Anything like that would have to be paid by taxpayers' money. In terms of the currency market, that generates additional uncertainty," he added.

A surge in oil prices to fresh record highs and global stock market losses also did not help the dollar.

High energy prices hurt the dollar because the United States is a heavy oil consumer.

The cost of crude surged to a record above $147 per barrel , while U.S. stocks fell sharply despite General Electric's

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[GE  Loading...      ()] in-line second-quarter profit.

"Unlike the turmoil of a year ago, which was accompanied by a rise in the dollar as carry trades unwound, today's turmoil is solely triggered by U.S.-specific events," said Ashraf Laidi, chief market analyst at CMC Markets in New York.

He added that the Federal Reserve may be forced to consider cutting interest rates this year again due to turbulent financial markets and the struggling U.S. economy.

That would be bad for the dollar and could send the euro above $1.60, Laidi said.

The dollar got a fleeting boost earlier in the session after data showed the U.S. trade deficit narrowed unexpectedly and U.S. import prices rose last month.