The dollar rallied sharply on Tuesday, boosted by a steep drop in oil prices and comments from a Federal Reserve official suggesting that U.S. interest rates may have to rise even before financial markets recover.
Remarks by U.S. Treasury Secretary Henry Paulson reiterating that a strong dollar was in the interest of the country also supported the greenback.
"U.S. officials are out in force this morning talking up the dollar and attempting to restore some stability in the financial markets," said Kathy Lien, chief strategist, at DailyFX.com.
"With U.S. Treasury Secretary Paulson saying 'a strong dollar is really very important' and Fed President Plosser calling for a rate hike before the economy turns around, it is not surprising to see the euro below $1.59," she added.
Philadelphia Fed President Charles Plosser said on Tuesday rising inflation could force the Fed to start raising interest rates amid a surge in inflation. Plosser is a voting member of the Fed's policy-setting committee.
Marc Chandler, head of global FX strategy at Brown Brothers Harriman in New York, said that while the comments by Paulson and Plosser supported the dollar, "short-term traders have been caught wrong-footed and stop-losses have been triggered." He added, "The drop in oil prices may also be encouraging a more optimistic hue."
Crude-oil futures fell $3.09 to settle at $127.95 a barrel after dipping as low as $125.63 -- the lowest level since early June. That boosted the dollar across the board, with the United States benefiting from lower crude prices because it is a heavy consumer of oil.
In midday trading in New York, the euro tumbled 0.8 percent to $1.5796, well below its record high of $1.6037 set last week, according to Reuters Dealing. Based on current prices, the single currency was on track for its biggest daily fall in nearly three weeks versus the dollar.
The euro slipped 0.1 percent to 169.29 yen, still within striking distance of its historic peak at 169.92 set on Monday. The dollar rose 0.7 percent to 107.14 yen.
Paulson Repeats Strong Dollar Policy
Paulson on Tuesday repeated that a strong dollar is "very important" to U.S. interests and that the underlying strength of the economy, as well as policies aimed at shoring up confidence, would be reflected in currency markets. His remarks gave the dollar an initial boost.
In remarks at the New York Public Library, Paulson also affirmed his commitment to supporting the government-sponsored housing finance giants Fannie Mae and Freddie Mac . He said restoring confidence in these agencies is crucial to stabilizing markets rattled by a year-old credit crunch and a sharp fall in home values.
Even with Plosser's hawkish comment, analysts remained skeptical that the Fed would raise interest rates this year given the extent of the U.S. downturn.
Persistent worries about the U.S. financial sector and the overall economy have continued to dampen sentiment toward the dollar. Earlier in the session, the greenback came under pressure following disappointing earnings from Wachovia and American Express .
Boris Schlossberg, senior currency strategist at DailyFX.com in New York, questioned the ability of the Fed to raise rates.
"We remain very dubious of them being able to do so, especially in light of the fact that yesterday's Amex earnings could be a signal that the U.S. consumer is starting to collapse," he said. "While the Fed may want to raise rates, the economic reality may force them to do otherwise."