Dollar Drops Most in Decade Against Yen as Lehman Goes Bankrupt

By Bo Nielsen and Ron Harui

Sept. 15 (Bloomberg) -- The dollar fell the most in a decade against the yen after Lehman Brothers Holdings Inc. filed for bankruptcy and traders speculated the Federal Reserve may need to cut interest rates to buoy financial markets.

The U.S. currency also dropped the most since June against the Swiss franc as American International Group Inc. sought capital to avoid credit downgrades. The dollar erased declines against the euro after Bank of America Corp. agreed to acquire Merrill Lynch & Co. and as investors sought the relative safety of U.S. Treasuries.

``Risk aversion is going through the roof,'' said Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi Ltd. in London. ``There is great deal of uncertainty on how this will affect the markets.''

The dollar weakened as much as 3.4 percent to 104.54 yen, the most since October 1998, and traded at 105.27 at 6:45 a.m. in New York, from 107.94 on Sept. 12. The U.S. currency traded at $1.4185 per euro, from $1.4224, and after weakening to $1.4481 earlier. It touched $1.3882 on Sept. 11, the strongest since Sept. 18, 2007.

The Japanese currency surged 2.7 percent to 149.38 per euro, the biggest jump since 2001, and rallied against all 16 major currencies as investors reduced so-called carry trades. In such transactions, funds are borrowed in a country with low interest rates and used to buy assets where returns are higher. Traders earn the spread between the two rates, taking the risk that currency market moves erase their profit.

`Pressure on Dollar'

The Australian dollar fell 4.1 percent to 85.29 yen, the biggest drop since November, and New Zealand's dollar declined 3.6 percent to 69.51 yen. Japan's benchmark interest rate is 0.5 percent, making the yen a favorite funding currency for the carry trade. The 15-nation euro region's key interest rate is 4.25 percent.

``The pressure on the dollar will be more emphasized against the low-yielders as markets remain volatile and risk reduction is the theme,'' said Ian Stannard, a senior currency strategist at BNP Paribas SA in London. The dollar may trade as low as 101 yen in the coming weeks, he said.

The U.S. currency fell as Lehman filed a Chapter 11 petition in the U.S. Bankruptcy Court for the Southern District of New York. The ICE's Dollar Index, a gauge measuring the dollar against the currencies of six U.S. trading partners, slipped 0.1 percent to 78.912 on concern that credit-market losses will spread to other financial institutions.

AIG, trying to stave off credit downgrades that would force it to post more than $13 billion in collateral, is seeking capital from buyout firms Kohlberg Kravis Roberts & Co. and J.C. Flowers & Co., said a person familiar with the situation yesterday. The insurer is seeking $40 billion from the Fed, the New York Times reported.

Merrill Purchase

Bank of America Corp. said in a statement today it agreed to acquire Merrill Lynch for about $50 billion, after shares in Merrill plummeted in the past week.

The dollar also declined as futures on the Chicago Board of Trade soared to a 86 percent chance that the Fed will lower its 2 percent target rate for overnight lending between banks by a quarter-percentage point, compared with no chance a week ago.

``In prior crises, after the initial sell-off in the dollar, the remainder of the day was all about moves back into the dollar on safe-haven flows as people go back into cash,'' said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. ``I expect dollar strength to be the core theme of the day.''

Swiss Franc

The yield on the two-year Treasury dropped 38 basis points to 1.81 percent, the biggest decline since the September 2001 terror attacks and the first time is has fallen below 2 percent since April, as investors sold higher-yielding assets.

The Swiss franc, which typically strengthens when trader aversion to higher-risk investments increases, rose 1.3 percent to 1.1155 per dollar, the biggest gain since June 6.

Stocks tumbled, with Standard & Poor's 500 Index futures expiring in December snapping three days of gains to slide 4 percent. The MSCI World Index of shares fell 1.4 percent. Markets in China, Hong Kong, Japan and South Korea were shut for holidays today.

China Cuts Rate

The dollar gained about 11 percent through to the end of last week since touching an all-time low of $1.6038 per euro on July 15.

``If the stress in the U.S. financial system intensifies, there's the potential for a partial retracement of the dollar's recent gains,'' Hardman said. The dollar may trade at $1.46 this week, he said.

China today cut its one-year lending rate by 27 basis points and lowered the reserve ratio by 1 percentage point at some of the banks, according to People's Bank of China, in response to the slowdown in the global economy.

The world may face ``Japan-like'' economic stagnation as turmoil in financial markets weighs on growth and challenges the ability of policy makers to manage the crisis, Tony Tan, deputy chairman of Government of Singapore Investment Corp., said yesterday.

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Ron Harui in Tokyo at rharui@bloomberg.net