Dollar Trades Near 1-Year High on U.S. Currency Funding Demand

By Daniel Kruger and Ye Xie

Oct. 2 (Bloomberg) -- The dollar traded near a one-year high against the euro on increased demand for funding in the U.S. currency, reflecting banks' reluctance to lend to each other amid a global credit crunch.

``There's a negative global sentiment, and the dollar seems to be the best place to put your money,'' said Jessica Hoversen, a foreign exchange analyst at MF Global Ltd. in Chicago. ``Credit is very tight.''

The dollar traded at $1.4007 per euro at 6:01 a.m. in Tokyo, after increasing 0.6 percent yesterday. It touched $1.3882 on Sept. 11, the strongest level since September 2007. The dollar was at 105.74 yen, following a 0.2 percent decline. The euro was at 148.15 yen, after dropping 1 percent.

Democratic and Republican leaders predicted that the U.S. financial rescue would win approval in the Senate and urged opponents in the House to drop their objections to the bill.

The Senate will vote after 7:30 p.m. Washington time on the legislation that links the rescue plan to an increase in bank- deposit-insurance limits and tax breaks. The House of Representatives will likely take action on Oct. 3, said Brendan Daly, a spokesman for House Speaker Nancy Pelosi.

The euro may fall for a fourth day against the dollar before today's meeting of the European Central Bank at which policy makers led by Jean-Claude Trichet are forecast to keep the main refinancing rate at 4.25 percent.

ECB `Traction'

``I don't think the euro can get a lot of traction out of Trichet,'' said Jeremy Stretch, a strategist in London at Rabobank International, the third-largest Dutch bank. ``If he is seen to be hawkish, the euro will fall, and if he is seen to open the gates, I think the euro will slide on that basis.''

Sterling fell yesterday as much as 1 percent to $1.7634, the lowest level since Sept. 12, after an industry report showed U.K. manufacturing contracted last month at its fastest pace in 16 years. Against the euro, the pound decreased as much as 0.5 percent to 79.53 pence.

The U.S. currency fell against the yen after the Tempe, Arizona-based Institute for Supply Management reported its factory index dropped last month to 43.5, the lowest since October 2001, from 49.9 in August. A reading of 50 is the dividing line between expansion and contraction.

The greenback may strengthen to $1.35 per euro in the next month as the global banking crisis widens in Europe and worsens in Iceland, according to Win Thin, a senior currency strategist at Brown Brothers Harriman & Co. in New York.

``No matter how bad the U.S. outlook is, people recognize Europeans are going through the same thing,'' Thin said. ``The strong dollar story is not over yet, despite the weak numbers.''

Icelandic Krona

The Icelandic krona tumbled yesterday as much as 5.2 percent to 111.51 against the dollar, the weakest since the central bank quit restricting its movement in March 2001, after debt-rating downgrades from Standard & Poor's and Fitch Ratings.

Iceland said this week that it would take a 75 percent stake in 104-year-old Glitnir Bank hf by investing 600 million euros ($859 million) after the institution's short-term funding dried up. The rescue followed bailouts in Europe in the wake of more than $550 billion in bank losses and writedowns.

The krona has fallen more than 28 percent over the past three months. ``It's a serious basket case,'' Thin said.

Foreign banks are paying near the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Federal Reserve increased the amount of funds available to other central banks this week to $620 billion.

Currency Swaps

The price on one-year cross-currency basis swaps between euros and dollars reached minus 120 basis points on Sept. 30, the largest effective premium for dollar borrowing in swaps since the euro's 1999 debut, according to data complied by Bloomberg. The price averaged close to zero from 1999 to the start of the subprime mortgage market collapse in August 2007.

A negative swap price indicates investors are willing to receive reduced interest payments on the euro they lend to obtain the needed financing in dollars.

``Because the money market is not working, you know that non-U.S. banks have a huge dollar funding position globally,'' said Hans Guenter Redeker, London-based global head of currency strategy at BNP Paribas SA, France's biggest bank.

Cross-currency basis swaps are agreements in which a trader borrows in a currency and simultaneously lends in a different one. The transaction involves the exchange of two different floating-rate payments, each denominated in a different currency and based on a different index.

The London interbank offered rate, or Libor, that banks charge each other for one-month dollar loans rose yesterday to the highest level since January, the British Bankers' Association said.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Ye Xie in New York at yxie6@bloomberg.net