Dollar Weakens Most Since January 2001 on U.S. Budget Deficit

By Ye Xie and Bo Nielsen

Sept. 23 (Bloomberg) -- The dollar weakened the most against the euro since January 2001 on concern a U.S. proposal to buy $700 billion of troubled assets from financial firms will inflate the budget deficit.

The greenback dropped for a fourth day yesterday in its longest stretch of decline since June as Treasury Secretary Henry Paulson's plan to bail out banks from the credit crunch failed to restore investor confidence in U.S. assets. Stocks fell, and oil prices surged as traders sought to unwind positions on the October contract's last day of trading.

``The massive increase in the deficit is starting to make people rethink the shape of all sorts of things, including the dollar,'' said Alan Ruskin, head of international currency strategy for North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut.

The dollar traded at $1.4786 per euro at 6:20 a.m. in Tokyo, after dropping 2.1 percent yesterday, when it touched $1.4866, the weakest level since Aug. 22. The dollar may slide to $1.50 in the next several weeks, according to Ruskin. The dollar was at 105.47 yen, following a 1.8 percent drop. The euro traded at 155.96 yen, after increasing 0.3 percent.

The U.S. currency has lost more than 6 percent versus the euro since touching a one-year high of $1.3882 on Sept. 11. The dollar reached $1.6038 on July 15, the weakest level since the European currency's 1999 inception.

The bailout plan, sent to Congress Sept. 20, would mark unprecedented government participation in markets and increase the nation's debt ceiling by 6.6 percent to $11.315 trillion. Officials may also provide $400 billion of guarantees for money- market funds.

Plotting Rescue

Paulson and Federal Reserve Chairman Ben S. Bernanke began plotting the rescue last week after New York-based Lehman Brothers Holdings Inc. filed for bankruptcy, the government seized control of American International Group Inc., and Merrill Lynch & Co. was forced into the arms of Bank of America Corp. Paulson and Bernanke are due to testify before the Senate today on the banking crisis.

The dollar will get ``crushed,'' as the extra spending reduces the allure of U.S. assets to foreign investors, said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion.

The yen rose 1.3 percent to 9.95 against the Mexican peso yesterday on reduced demand for carry trades, in which traders get funds in a country with low borrowing costs and invest where returns are higher. The Bank of Japan's target lending rate of 0.5 percent compares with 8.25 percent in Mexico.

`Severe Slowdown'

``Even with a plan, the likelihood there will be a very severe slowdown in the U.S. and elsewhere has increased,'' said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. ``I don't think people will return to the same old risk-taking world.''

The Standard & Poor's 500 Index retreated 3.8 percent yesterday, led by regional banks that may get hurt by the bailout. Crude oil for October delivery rose 14.8 percent to $120 a barrel on the New York Mercantile Exchange. The more- active November contract rose $6.62.

The rand weakened 0.7 percent to 7.9762 per dollar yesterday as South African President Thabo Mbeki's resignation increased speculation foreign investors will sell the country's assets on extended global financial turmoil. The currency dropped 3.4 percent to 11.8472 against the euro.

The chance of the Fed cutting its benchmark 2 percent rate by a quarter-percentage point at its Oct. 29 policy meeting was 38 percent yesterday, compared with zero a month ago, futures contracts on the Chicago Board of Trade showed. The European Central Bank's main refinancing rate is 4.25 percent.

Economic Reports

Home resales declined to 4.94 million last month from 5 million in July, according to the median forecast of 70 economists surveyed by Bloomberg News. The National Association of Realtors' report is scheduled for release tomorrow. The Commerce Department is forecast to report the next day that sales of new houses dropped to 510,000 from 515,000 and that durable goods orders fell 1.8 percent.

``We look for the dollar to reflect the weakness in the U.S. economy,'' said David Powell, a currency strategist at Bank of America in London. ``The dollar is not yet receiving the yield support that would normally be acquired in order to support a sustained rally.''

The yield advantage of two-year German bund over the comparable-maturity U.S. Treasury notes widened to 1.90 percentage points yesterday, from 1.66 at the beginning of the month, making the U.S. assets less attractive.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net