Yen Falls Versus Euro as Bailout Revives Higher-Yield Demand

By Ye Xie and Bo Nielsen

Sept. 20 (Bloomberg) -- The yen posted the biggest drop against the euro since May as the U.S. government's plan to revive financial markets encouraged investors to resume buying higher-yielding assets funded by low-cost loans in Japan.

Japan's currency dropped versus New Zealand's dollar and the pound this week on speculation investors will resume carry trades after the U.S. Treasury and the Federal Reserve proposed cleaning up financial firms' troubled assets. A gauge of currency volatility reached the highest in almost a decade.

``For now, a short-term bottom is put in place,'' said Brian Kim, a currency strategist at UBS AG in Stamford, Connecticut. ``In the short term, it's positive for risk appetite. They may have avoided the worst-case scenario, but the banking crisis is clearly harmful for the U.S. economy.''

The yen fell 1.3 percent to 155.46 per euro yesterday, from 153.42 on Sept. 12. It touched 155.53 yesterday, the weakest level since Sept. 8. The U.S. currency dropped 1.7 percent this week to $1.4466 per euro in its biggest decline since March 28. The dollar fell 0.5 percent to 107.45 yen.

Volatility in options for the dollar against seven major currencies spiked to 16.69 percent on Sept. 17, the highest since October 1998, according to a JPMorgan Chase & Co. index.

Treasury Secretary Henry Paulson said yesterday that the U.S. government will spend ``hundreds of billions of dollars'' to cleanse banks of troubled assets and halt an exodus of investors from money markets. Congressional leaders said they intend to pass legislation within days.

Government Takeovers

The government took over American International Group Inc., Fannie Mae and Freddie Mac in the past two weeks, a period during which Lehman Brothers Holdings Inc. filed for bankruptcy, Merrill Lynch & Co. agreed to be sold to Bank of America Corp., and Americans pulled a record $89 billion from money-market funds.

Investors sold the U.S. dollar yesterday and bought back high-yielding currencies including the euro to cover their bets against them after the Paulson announced his plan, said Scott Ainsbury, a portfolio manager who helps manage about $12 billion in currencies at New York-based trader FX Concepts Inc.

The greenback fell 3.2 percent this week to 68.91 cents versus the New Zealand dollar, the first weekly drop since Aug. 22. Against the British pound, it decreased for a second week, dropping 2.3 percent to $1.8353.

The ICE's Dollar Index, a gauge measuring the greenback against the currencies of six U.S. trading partners, fell 1.6 percent this week to 77.68.

The dollar fell 3 percent against the yen on Sept. 15, the biggest daily drop in a decade, after Lehman filed for bankruptcy, sparking a global stock-market rout. The U.S. government's $85 billion rescue of AIG failed to calm investors.

Flagship `Crushed'

``The dollar will suffer mildly once investors wake up to what happened and what's going on,'' said Kenneth Rogoff, a professor of economics at Harvard University, in an interview on Bloomberg Radio. ``At the end of the day, the financial sector is our flagship. It has been crushed, and that's going to have a big impact on international capital flows. I don't think investors have quite woken up to this.''

The yen dropped 2.2 percent to 73.65 against New Zealand's dollar and 1.4 percent to 196.39 versus the pound this week on revived demand for trades in which investors get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 7.5 percent in New Zealand and 5 percent in the U.K.

Eisuke Sakakibara, 67, a professor at Tokyo's Waseda University who was dubbed ``Mr. Yen'' because of his ability to influence the foreign-exchange market during his 1997-1999 tenure at Japan's Finance Ministry, said in an interview on Bloomberg Television yesterday that there's ``no quick fix'' for credit turmoil. He said the yen may strengthen to 100 against the dollar this year.

Dollar Reserves

Foreign central banks may reduce dollar reserves as the U.S. bailout causes the budget deficit to swell, according to John Brynjolfsson, chief investment officer of Armored Wolf LLC, a hedge fund in Aliso Viejo, California.

``I can't imagine they wouldn't be having high-level discussions about the appropriateness of dollar-concentrated reserve strategies going forward,'' said Brynjolfsson, who formerly managed $80 billion at Newport Beach, California based Pacific Investment Management Co.

The dollar accounted for 63 percent of currency reserves in the world at the end of March, dropping from 71 percent at the end of 2000, according to the International Monetary Fund. The euro's share increased to 27 percent, from 18 percent.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net

Last Updated: September 20, 2008 08:00 EDT