The U.S. dollar stayed within sight of a six-week high against a basket of currencies on Tuesday as concerns that politicians on both sides of the Atlantic were failing to tackle huge debt burdens weighed on investor appetite for risk.

Perceived riskier currencies regained some ground after coming under pressure during the previous session, but severe dollar funding strains continued to support the U.S. currency as European banks scrambled to secure cash dollars.

Signs the dollar money market was seizing up added to investor concerns the spiralling euro zone debt crisis could pummel European banks.

The dollar index was last trading down 0.2 percent on the day at 78.131, within reach of Monday's peak of 78.516. The failure of a super committee of U.S. lawmakers to reach agreement on a deficit cutting plan prompted investors to reach for the safety of the world's most liquid currency.

The euro was up 0.3 percent on the day at $1.3536, with short covering helping the single currency climb off session lows around $1.3469.

We have recovered a bit off the lows but the risk environment is going to be still very challenging. The big events in the U.S. and Europe are still coming out as negative and providing a bearish backdrop for investors, said Ian Stannard, head of European FX strategy at Morgan Stanley.

Any rebounds in the euro are going to be fairly short-lived. Dollar funding concerns are still a very big factor and are keeping risk appetite quite constrained.

Stannard said apart from a brief spike higher on Friday the euro's upside had been capped around the $1.3550 level over the past week and he expected the euro to retreat if it failed to break above there today.

Stress in the dollar money market showed no sign of abating after the three-month euro/dollar swap spread rose to 140 basis points on Monday, the highest level since late 2008. It was last around 138 basis points.

Everything is reminiscent of the days after the collapse of Lehman Brothers, said a trader at a Japanese bank.

EYE OF THE STORM

Market players said speculation that the already huge bets made against the euro could lead to further bouts of short covering has helped support the single currency above a six-week low of $1.3421 hit last week.

Data from the Commodity Futures Trading Commission showed last Friday that speculators had already piled on bearish bets and net euro short positions rose to 76,147 contracts.

Talk of ongoing repatriation of foreign assets by European players has also helped put a floor under the single currency and discouraged short-sellers.

Still, the common currency could be under renewed pressure soon unless policymakers come up with drastic measures to stop investors dumping euro-zone government bonds.

Some market players, including myself, are hoping that policymakers break new ground on the joint bond idea this week. If there is no progress on that front, the euro could slip back, said Teppei Ino, a currency analyst at the Bank of Tokyo-Mitsubishi UFJ.

The European Commission has set out in a paper to be published on Wednesday how closer monitoring of countries' budgets could in the long run make it possible to issue jointly underwritten euro-zone debt.

The dollar got a small lift against the yen after some traders took comments by Finance Minister Jun Azumi as hinting at more intervention by Japan, although he in fact merely stated that huge buying of foreign bonds by the Bank of Japan -- an idea floated by some economists -- would not be in line with government thinking.

The greenback briefly rose to as high as 77.35 yen but quickly ceded gains to stay around 76.96 yen.

The Australian dollar pared heavy losses incurred on Monday to stand at $0.9883, up 0.3 percent on the day but still below a support-turned-resistance level of around $0.9910, a 61.8 percent retracement of the October rally.