Yen Declines Against Euro as Bank Rescues Support Carry Trades

By Anchalee Worrachate and Stanley White

Oct. 14 (Bloomberg) -- The yen fell against higher-yielding currencies after governments in the U.S., Europe and Australia pledged to support banks, encouraging investors to increase holdings of euros, pounds and Australian dollars.

The U.S. Treasury will buy stakes in banks including Citigroup Inc. and JPMorgan Chase & Co., people briefed on the plan said. European countries committed $1.8 trillion to guarantee loans and invest in lenders yesterday.

``Policy makers have come up with the right initiatives to tackle the credit issue, and that does a great deal in restoring confidence,'' said Neil Jones, head of European hedge fund sales in London at Mizuho Capital Markets. ``In the near term, these measures will boost risk appetite. Investors will buy stocks and sell the yen for higher-yielding currencies.''

The yen fell 1.8 percent to 141.07 per euro at 7:53 a.m. in New York, from 138.57 yesterday. It's headed for the biggest two-decline since January 2001. Against the dollar, the yen dropped 0.8 percent to 102.85 from 102.01. The euro rose 1.2 percent to $1.3742 from $1.3581. The pound advanced 1.5 percent to $1.7607 from $1.7341.

Japan's currency will rebound to beyond 130 per euro by the end of the year because the global economy will stagnate irrespective of the bank-rescue packages, boosting demand for safest assets, Jones said.

Against the Australian dollar, the yen plunged 3.9 percent to 74.04. Japan's currency fell 3.4 percent versus the New Zealand dollar to 65.20. South Korea's won climbed 3.4 percent to 11.74 versus the yen.

Carry Trades

Japan's currency has gained 13 percent versus the Australian dollar and 9 percent against the New Zealand dollar this month as credit-market losses prompted investors to sell higher-yielding currencies. Japan's benchmark rate is 0.5 percent, compared with 6 percent in Australia and 7.5 percent in New Zealand.

Volatility implied by one-month dollar options against Japan's currency declined yesterday by the most in almost 13 years, reducing the risk of carry trades, in which investors borrow currencies with low interest rates and invest in nations with higher central bank yields.

``Volatility has been falling broadly as we move out of a panic mode,'' wrote analysts led by Hans-Guenter Redeker, London-based global head of foreign-exchange strategy at BNP Paribas SA, in a research note yesterday. ``We expect risk appetite to stay strong, putting yen crosses under pressure.''

Currency Volatility

Implied volatility on one-month dollar-yen options dropped to 20.98 percent today from 23.67 percent yesterday, when it tumbled by 5.97 percentage points, the most since Bloomberg began compiling the data in December 1995.

The Swiss franc, another popular funding currency in carry trades, fell 2.3 percent against the Australian dollar and 1.5 percent against the South African rand as sentiment improved.

Calyon, the investment-banking unit of Credit Agricole SA, said investors should sell the Swiss currency and buy the Aussie dollar as the franc may fall to 89.80 cents in the next two weeks.

``This is a short-term play to capitalize on the current euphoria,'' said Daragh Maher, deputy head of global currency strategy at Calyon, in a note to clients. ``We accept that it may not persist once the reality of economic weakness re- emerges.''

Stocks around the world rallied, with the MSCI World Index rising 3.1 percent. The Standard & Poor's 500 Index yesterday rose by the most in seven decades.

`Rid of the Panic'

``The governments have gotten rid of the panic situation, which is very good,'' said Toru Umemoto, chief currency analyst at Barclays Capital in Tokyo. The yen may decline to 103 against the dollar in the coming week, he said.

The Bush administration will assign about half of a total of $250 billion for stakes in banks, people briefed on the matter said. The banks are Citigroup, Wells Fargo & Co., JPMorgan, Bank of America Corp., Goldman Sachs Group Inc., Morgan Stanley, State Street Corp., and Bank of New York Mellon Corp., they said. Treasury Secretary Henry Paulson is scheduled to hold a press conference at 8:30 a.m. in Washington.

Losses in the dollar accelerated against the euro after the Federal Reserve said yesterday the European Central Bank, the Bank of England and the Swiss National Bank will offer financial institutions unlimited funds in the U.S. currency.

The London interbank offered rate, or Libor, for three- month dollar loans dropped 7 basis points to 4.75 percent yesterday, the British Bankers' Association said. Japan and Australia pumped $9.1 billion today into money markets after European leaders agreed to guarantee new debt from financial institutions and use taxpayer money to rescue banks.

Morgan Stanley View

Currency strategists and investors say Europe's actions may not prevent the region's economy from slowing. Morgan Stanley predicts a decline in the euro to $1.25 by 2009, from $1.3581 yesterday and $1.60 in July, and strategists at BNP Paribas see weakness after ``some support in the near term.''

``The euro was overbought, over-owned, over-rated and overvalued,'' said Stephen Jen, the global head of currency research at Morgan Stanley in London. Jen correctly predicted in July that the euro would slump just as it began to weaken 15 percent. ``The strategic view has to be that a global recession will keep seeing the euro sold off.''

Japan may halt sales of government-held shares to help protect financial markets from the global credit crisis, Finance Minister Shoichi Nakagawa said in a statement today. Japan will also take steps to tighten restrictions on short-selling, while relaxing regulations on share buybacks to limit the spread of the global financial crisis.

``Measures from Japan could lead to a further rebound in stocks and help stabilize financial markets,'' said Kengo Suzuki, currency strategist at Shinko Securities Co. in Tokyo. ``This could actually weaken the yen on an increase in risk appetite.''

To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net; Stanley White in Tokyo at swhite28@bloomberg.net

Last Updated: October 14, 2008 07:57 EDT