Yen Volatility Falls to 7-Month Low as Fed Keeps Rates on Hold

By Kosuke Goto

Aug. 6 (Bloomberg) -- Volatility for dollar-yen options fell to the lowest in seven months after the Federal Reserve left borrowing costs unchanged at 2 percent for a second meeting.

Volatility, a gauge of expected exchange-rate fluctuations, slid 2 percent, the most in a week, as U.S. and Asian stocks rose on the Fed's statement that inflation will moderate. Demand waned for options that protect against further gains in the yen.

``The Fed meeting, a major risk event, was gone,'' said Ryousei Ishida, senior vice president of foreign-exchange options at Mizuho Corporate Bank Ltd. in Tokyo. ``With markets calming down, options traders are letting down their guard against any panic yen-buying, pushing down the volatility.''

Implied volatility on one-month dollar-yen options fell to 9.6550 percent as of 6:26 a.m. in London, the lowest since Dec. 27, from 9.8525 percent yesterday.

So-called risk-reversal rates on dollar-yen options show traders paid the smallest premium since July 11 for yen calls, which grant the right to buy the currency, versus puts, which give the right to sell.

The risk-reversal rate on one-month options was at minus 2.8250 percent compared with minus 3.9925 percent on July 16, the lowest level since April. A negative value indicates greater demand for yen calls.

Declining Risk

The risk reversal rate reached minus 6.85 on March 17, as traders dumped investments funded by loans in Japan. The yen reached an almost 13-year high of 95.76 per dollar on that day, after the Fed's emergency weekend cut in its discount rate and the sale of Bear Stearns Cos. to JPMorgan Chase & Co.

Japan's currency traded at 108.32 yen a dollar from 108.35 in New York late yesterday.

Falling volatility may weaken the yen by giving investors confidence to borrow in Japan, which has the lowest interest rates among major economies, and buy assets in higher-yielding markets in so-called carry trades.

In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency moves erase those profits.

To contact the reporter on this story: Kosuke Goto in Tokyo at kgoto2@bloomberg.net