Yen Rises Against Euro, Dollar as Investors Reduce Carry Trades

By Bo Nielsen and Lukanyo Mnyanda

Feb. 11 (Bloomberg) -- The yen rose against the euro and dollar after Group of Seven officials warned of further financial-market turmoil, prompting investors to reduce holdings of higher-yielding assets bought with loans from Japan.

Japan's currency extended its gains versus the euro and dollar this year to 4.6 percent after the G-7 in a meeting this weekend estimated global banks will write down $400 billion because of losses on U.S. subprime mortgages. The Australian dollar advanced after the nation's central bank said it's likely to keep raising borrowing costs.

``The market is feeling in this environment risk trades are going to be problematic,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``The G7 message is that there's more bad news in the works.''

The yen strengthened to 155.20 per euro at 8:51 a.m. in New York, from 155.71 on Feb. 8. Japan's currency advanced to 106.92 per dollar, from 107.30. The euro traded at $1.4513, from $1.4504, after falling 2 percent last week, the most since September 2006.

The yen pared its gains as shares in Europe rose. Germany's DAX index gained 0.5 percent, after a drop of as much as 1.1 percent earlier that signaled investors were exiting bets on higher-returning assets.

`Downside Risks'

Finance ministers and central bankers ended a weekend meeting in Tokyo with a statement that ``downside risks persist,'' including the U.S. housing slump and tighter credit conditions. The G-7 estimates banks worldwide will suffer writedowns of $400 billion, German Finance Minister Peer Steinbrueck said. Financial institutions have marked down about $146 billion of losses since the start of 2007.

Australia's dollar gained as the Reserve Bank of Australia raised its inflation forecast in its quarterly statement, prompting traders to increase bets policy makers will add to last week's rate increase. The currency gained 1 percent to 90.46 U.S. cents and 0.5 percent to 96.54 yen.

``The RBA was hawkish, reinforcing the outlook for another rate hike,'' said Norifumi Yoshida, vice president of the trading section in Singapore at Mizuho Corporate Bank Ltd., a unit of Japan's second-largest bank.

Japan's benchmark interest rate of 0.5 percent compares with 7 percent in Australia, 3 percent in the U.S. and 4 percent in Europe.

Power Shortage

The yen rose 0.5 percent against the South African rand, a favorite of so-called carry trades that's also being hurt by a power shortage that has disrupted mining of precious metals and minerals. These commodities account for 60 percent of exports. The rand has slumped almost 4 percent versus the currency this month, to 13.72 yen.

``The currency is the share price of a country,'' said George Glynos, managing director of Johannesburg-based Econometrix Treasury Management, which advises investors on bond and currency holdings. ``If anyone wants to know what foreigners are thinking about South Africa at the moment, they need look no further than the rand.''

The rand slumped almost 6 percent versus the U.S. currency last week, the largest weekly drop since June 2006, to 7.7882. It was little changed at 7.7937 per dollar today.

The G-7 consists of the U.S., the U.K., Canada, Italy, France, Germany and Japan.

Volatility Rises

Increasing fluctuations in exchange rates are also undermining investors' appetite for carry trade bets. Implied volatility on one-month U.S. dollar-yen options rose to 12.03 percent today, from 11.58 percent on Feb. 8. Dealers quote implied volatility, a gauge of expectations for currency moves, as part of pricing options.

In the carry trade, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the two. Rising volatility raises the risk that currency swings will erase profits from rate differentials.

The Canadian dollar declined against 12 of the 16 most- active currencies after Bank of Canada Governor Mark Carney signaled at the G-7 meeting that he will lower borrowing costs. Canada's currency weakened to 106.80 yen from 107.40 yen.

The euro gained against the dollar earlier after European Central Bank council member Axel Weber said in an interview with the Frankfurter Allegemeine Zeitung newspaper the central bank is still concerned about inflation developments.

Different Situation

``Inside the governing council we had no calls for an increase of rates, but equally no calls for cutting the rates,'' ECB Governor Jean-Claude Trichet said in an interview with Japan's Nikkei newspaper and Kyodo News on Feb. 10. He said yesterday the 15-nation region is ``not in the same situation'' as the U.S, where the Federal Reserve has cut interest rates five times since September.

The euro posted its biggest five-day loss in more than 1 1/2 years last week after Trichet and other ECB policy makers left the main interest rate unchanged and said the economic outlook had worsened.

German two-year notes yield 1.16 percentage points more than similar-maturity Treasuries, down from 1.32 percentage points a week ago.

Source : Bloomberg.com