Dollar Declines to 2 1/2-Year Low Against Yen on Credit Losses

By Lukanyo Mnyanda and Ron Harui

Jan. 16 (Bloomberg) -- The dollar fell to a 2 1/2-year low against the yen as losses in credit markets widened and the U.S. economy showed more signs of sinking into recession.

The U.S. currency also dropped to a record low against the Swiss franc on analysts' expectations Merrill Lynch & Co. and JPMorgan Chase & Co. will follow Citigroup Inc. in writing down the value of investments linked to U.S. mortgages. The yen climbed against higher-yielding currencies such as the South African rand and the New Zealand dollar as a slump in global stocks prompted investors to reduce carry trades funded with cheap loans from Japan.

``Further weakness is in store for the dollar as financial companies under-perform,'' said Kamal Sharma, a London-based currency strategist at Bank of America Corp., the second-largest U.S. bank. ``The equity markets are shaky and the yen should remain robust.''

The dollar dropped for a fifth day, to 106.11 yen as of 11:40 a.m. in London, from 106.78 yesterday in New York. It traded as low as 105.92, the first time it's been below 106 since May 2005.

The U.S. currency declined to $1.4772 per euro, from $1.4804 yesterday, when the common European currency climbed to $1.4922, the strongest since the record high of $1.4967 in November. It fell to 1.0838 against the Swiss franc, an all-time low, and was at 1.0916, from 1.0929 yesterday.

The yen advanced to 156.74 per euro after reaching the strongest since Sept. 11, from 158.08 yesterday. It rose 0.9 percent against the British pound, climbing to 207.44, from 209.58 yesterday.

ECB's Weber

The European single currency extended declines against the dollar and the yen after European Central Bank policy maker Axel Weber said euro-zone inflation may fall below the bank's 2 percent ceiling next year. Figures today showed inflation stayed above target last month.

The Japanese currency climbed the most against the New Zealand dollar and rand, favorites of carry-trade investors. It climbed 1.9 percent to 81.40 per New Zealand dollar, after a 3 percent increase yesterday. It was at 15.30 per rand, gaining more than 4 percent over two days.

The currency gained as the MSCI Asia-Pacific Index of regional shares slumped 3.5 percent, European stocks measured by the Dow Jones Stoxx 600 Index fell 1.3 percent, and the risk of the region's companies defaulting on their debt rose. Futures on the Standard & Poor's 500 dropped as much as 1.1 percent.

Contracts on the Markit iTraxx Crossover Index of 50 European companies with mainly high-risk, high-yield credit ratings jumped 12 basis points, according to Deutsche Bank AG. The index, a benchmark for the cost of protecting bonds against default, rises when perceptions of credit quality deteriorate.

U.S. Banks

Merrill, the world's biggest brokerage, will report a record loss of $3.23 billion for the fourth quarter tomorrow, while JPMorgan Chase & Co., the nation's third-largest bank, will say earnings dropped 29 percent to $3.21 billion, analysts estimate.

Bank of America Corp. lowered its forecast for the dollar in a research note yesterday because of ``market expectations'' of a recession. The sixth-largest currency trader cut its outlook for March 31 to $1.48 from $1.45 previously and to 109 yen from 112.

Fed funds futures contracts on the Chicago Board of Trade show a 100 percent likelihood the Fed will lower the target overnight lending rate between banks by at least a half- percentage point to 3.75 percent on Jan. 30. The chance of a cut to 3.5 percent is 40 percent, compared with zero a week ago. The main rate in the euro-area is 4 percent.

The government may say today that industrial production fell 0.2 percent in December, after a 0.3 percent increase in November, according to a Bloomberg News survey of economists before the report due at 9:15 a.m. in Washington.

U.S. Inflation

A separate government report may show the rate of change in the consumer-price index slowed to 0.2 percent last month, after a 0.8 percent increase in November, according to a separate Bloomberg survey of economists. The Treasury Department will also publish figures that may show foreign buying of U.S. financial assets more than halved from last month's $114 billion.

The difference in yield, or spread, between German two-year notes and same-maturity Treasuries has widened 26 basis points since the last trading day of 2007. It was at 115 basis points today.

The Japanese currency reached the highest in four months versus the euro as rising volatility spurred investors to sell higher-yielding assets. Japan's benchmark interest rate of 0.5 percent compares with 8.25 percent in New Zealand and 11 percent in South Africa.

``Investors don't want to take risks at this stage, with some of them probably cutting foreign assets,'' said Seiichiro Muta, director of foreign exchange in Tokyo at UBS AG, the world's second-largest currency trader. The yen may advance to 157 per euro today, he forecast.

Currency Swings

Volatility implied by one-month dollar-yen options rose to 14.75 percent, the highest since Nov. 27, from 13.65 percent yesterday. An increase in volatility may discourage carry trades as it implies greater exchange-rate fluctuation risk.

In carry trades, investors borrow in countries with lower interest rates and invest in those with higher borrowing costs, earning the spread between the two.

The inflation rate in the euro area was 3.1 percent in December, matching an estimate published on Jan. 4, the European Union's statistics office in Luxembourg said. Inflation averaged 2.1 percent in 2007, the eighth successive year it's been above the ECB's ceiling.

ECB President Jean-Claude Trichet, who is due to speak in Frankfurt at 7:55 p.m., said last week policy makers were prepared to act ``preemptively'' to quell inflation.

``The commentary from ECB officials in the past week has clearly been on the hawkish side,'' said John Horner, a currency strategist at Deutsche Bank AG in Sydney, in an interview with Bloomberg Television. ``The risk that they see is rates may need to go up further. That should push the euro against the dollar through the $1.50 mark.''

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net ; Ron Harui in Singapore at rharui@bloomberg.net

Last Updated: January 16, 2008 06:43 EST

Source : Bloomberg.com