Dollar May Rebound Next Year on Rates, Deutsche's Fukaya Says

By Stanley White

July 17 (Bloomberg) -- The dollar may rise against the yen next year as the U.S. weathers the credit-market slump and the Federal Reserve raises interest rates to slow inflation, according to Deutsche Bank AG.

The Fed will be able to raise rates as U.S. regulators have avoided a collapse of the financial system after the subprime mortgage meltdown, Koji Fukaya, Deutsche's senior currency strategist in Tokyo, said yesterday. The dollar may approach 110 yen provided the yield spread on 10-year Treasuries over similar maturity Japanese government bonds widens to 2.5 percentage points, Fukaya at the world's largest currency trader said.

``The foreign-exchange market has yet to fully respond to the receding risks of financial system collapse,'' Fukaya said at a Bloomberg seminar. ``People will start to focus more on rates. It may take some time, but the dollar should recover.''

The U.S. currency fell to 104.94 yen at 1:35 p.m. in Tokyo from 105.13 yen yesterday, when it declined to 103.77 yen, the lowest since May 27.

The 10-year yield spread between U.S. and Japanese government notes was 2.33 percentage points, down from a two- week high of 2.35 percentage points reached yesterday.

The dollar slid this year to a 12-year low versus the yen as delinquencies on loans to U.S. homeowners with poor credit caused more than $400 billion in losses at global financial institutions and Bear Stearns Cos. only avoided collapse by being rescued by the Fed.

Safety Net

U.S. Treasury Secretary Henry Paulson announced on July 13 a plan to purchase shares in Fannie Mae and Freddie Mac if necessary to boost confidence in the two largest buyers of U.S. mortgages.

``Some form of a safety net is being put in place,'' Fukaya said. ``The situation is a lot different now than when Bear Stearns rattled financial markets.''

Inflation is too high and is a top priority, Fed Chairman Ben S. Bernanke told U.S. lawmakers yesterday as data showed consumer prices rose 5 percent in June, the biggest increase in 17 years.

Futures on the Chicago Board of Trade show a 42 percent chance the Fed will raise its 2 percent target rate for overnight lending between banks by a quarter-percentage point at its meeting on Jan. 28, 2009, compared with 39 percent odds a week ago. The Fed lowered rates seven times between September and April from 5.25 percent to ward off a recession.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net