LONDON - The dollar rallied against the yen and the Swiss franc on Monday as investors unwound safe-haven plays on expectations US lawmakers would pass a deal to raise the country's borrowing limit, averting the risk of an immediate default. Investors covered short positions in the dollar after a sell-off in the past week or so, but many in the market were sceptical that the plan would be enough for Washington to hold onto its prized triple-A credit rating. The US Senate is expected to pass the deal, which raises the debt ceiling and cuts about US$2.4 trillion (S$2.88 trillion) from the deficit over the next decade, on Monday. Analysts expect dollar selling could re-emerge if ratings agencies suggest those cuts are not sufficient for the United States to improve its fiscal position. "There will be relief in market sentiment today and maybe this week, as the US will avoid a default, but the problems are not fully solved so I think it will be a muted reaction,"said Richard Falkenhall, currency strategist at SEB in Stockholm. "You have the risk of ratings agency downgrades, and no further fiscal stimulus in this deal," he said, adding that this would be negative for the dollar. In early European trade, the dollar traded 0.7 per cent higher on the day at 77.28 yen, having climbed to as high as 78.05 yen in earlier trade. It pulled back from a four-month low of 76.70 yen hit last week, but remained in range of an all-time trough of 76.25 yen, given lingering worries of a US sovereign downgrade, as well as concerns about the outlook for US economic growth. A further yen appreciation will keep alive the possibility of yen-selling intervention by Japanese authorities, which have argued against a rising currency. Against the Swiss franc, the US currency was 0.3 per cent higher at 0.7880 francs, recovering from a record low near 0.7850 francs hit late last week. The dollar trimmed gains as news about the deal prompted some investors to pick up currencies perceived to be higher risk, prodding the euro up 0.3 per cent to a session high around US$1.4455. The Australian dollar rose half a per cent on the day, while the New Zealand dollar nudged up 0.2 per cent. Both currencies often appreciate on demand for risky assets. 'UNDERWEIGHT DOLLARS' Despite the mild rally in the dollar versus safe-haven currencies, traders pointed out that the greenback's recovery had been relatively limited given that it fell nearly 7 per cent versus the franc and 3.5 per cent against the yen last month. The latest IMM data shows net short positions in the dollar held by speculators jumped last week, valuing US$25.42 billion according to Reuters calculations. Analysts said this was the biggest net short position since early May. Even as some of those positions were trimmed on Monday, some traders said that, if anything, the market was positioned for the possibility of a US downgrade. Thanos Papasavvas, head of currency management at Investec Asset Management, said he remained underweight on the dollar as the United States will continue to struggle to get its fiscal situation in order as the economy posts a slow recovery. "Even if this plan goes through, it won't change things much," said Papasavvas, who is responsible for around $10 billion in assets under management. "(Because of) the structural story, the cyclical story, and the reserves story, we have a pretty negative outlook on the dollar," he said, adding he saw a "decent" possibility that Washington would lose its triple-A status. He said he remained overweight euros and Asian and emerging currencies, and that he had largely stayed pat on currency positions in the past weeks. Demand for risky assets was dampened by sluggish manufacturing purchasing managers' surveys for many euro zone countries on Monday, which highlighted economic weakness in the region as struggling periphery countries require more assistance to help repay their debts. Some traders said Spain's surprise announcement on Friday that it would call an early general election ratcheted up political uncertainty in the euro zone, which may ultimately have some impact on how much more bailout funds countries including Greece may receive.

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