Dollar Drops, Set for Weekly Decline, as U.S. Debates Rescue

By Stanley White and Ron Harui

Sept. 26 (Bloomberg) -- The dollar fell, heading for a second weekly decline against the yen, as U.S. lawmakers disagreed over a finance industry rescue plan and Washington Mutual Inc. became the nation's biggest bank to collapse.

The greenback was on course for a weekly loss against the euro after a group of Republicans opposed to the Treasury's $700 billion asset-purchase plan entered negotiations with an alternative proposal. The yen headed for weekly gains against the Australian and New Zealand dollars as investors pared so- called carry trades on concern the talks will drag on.

``The U.S. needs to act quickly, because the financial system and the dollar are at risk,'' said Akio Shimizu, chief manager of currency trading in Tokyo at Mitsubishi UFJ Trust & Banking Corp., a unit of Japan's largest publicly listed lender. ``Congressional discussions over the rescue package aren't going smoothly at all.''

The dollar declined to 105.90 yen at 11:41 a.m. in Tokyo from 106.56 late yesterday in New York, on course for a 1.4 percent decline this week. It also fell to $1.4667 per euro from $1.4609 yesterday and $1.4466 on Sept. 19. The euro bought 155.33 yen, down 0.2 percent from late yesterday and little changed for the week.

The Australian dollar bought 88.61 yen, down 1.1 percent from a week ago, while the New Zealand dollar fell 1.7 percent to 72.78 yen.

New Proposal

In carry trades investors get funds in countries with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 7 percent in Australia and 7.5 percent in New Zealand. The risk is that currency moves erase profits.

The new proposal to ease a U.S. credit crisis came after President George W. Bush met with Republican presidential candidate John McCain and Democratic rival Barack Obama to discuss the financial-markets rescue, according to Senate Banking Committee Chairman Christopher Dodd.

Dodd, Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben S. Bernanke had been pursuing a plan that would use taxpayers' money to buy troubled assets from financial companies. The rival proposal calls for a mortgage-backed security insurance fund financed by premiums from the holders of those securities. Paulson rejected the latter, according to House Financial Services Committee Chairman Barney Frank.

Washington Mutual

The U.S. government closed Seattle-based Washington Mutual, which faced $19 billion of mortgage-related losses, after customer withdrew $16.7 billion since Sept. 15, the Office of Thrift Supervision said in a statement. JPMorgan Chase & Co., the third-biggest U.S. bank by assets, agreed to acquire WaMu's deposits and branches for $1.9 billion.

``This is a negative story for the dollar,'' said Motonari Ogawa, director of currency trading in Tokyo at Barclays Capital Inc., a unit of the U.K.'s third-biggest bank. ``News about Washington Mutual will make the market nervous and people will doubt whether a U.S. rescue plan will work.''

The yen may extend gains as the VIX volatility index closed above 30 for nine straight days, showing markets are facing a shock similar to the 1997 Asian currency crisis and 2001 terrorist attacks, according to JPMorgan Chase & Co.

The VIX index, a Chicago Board Options Exchange gauge reflecting expectations of stock market price changes and a barometer of risk aversion, was at 32.82 late in New York yesterday headed for its fifth weekly gain. It rose to 42.16 on Sept. 18, the highest since October 2002.

``This indicates risk aversion, which in the current environment could support the yen,'' said Yen Ping Ho, a currency strategist at JPMorgan Chase in Singapore. ``Japanese investor buying of foreign assets has also slowed recently, which suggests less support against the dollar-yen's downside.''

Portfolio Flows

Japanese investors were net sellers of 606.9 billion yen ($5.73 billion) of foreign securities in the week ended Sept. 20, based on reports from designated major investors released by the Finance Ministry in Tokyo today. They sold 654.6 billion yen more overseas assets than they bought the previous week.

The collapse of Lehman Brothers Holdings Inc. and the U.S. government takeover of insurer American International Group Inc. have helped cause credit markets to seize up. The three-month London interbank offered rate, or Libor, for dollars rose to 3.77 percent yesterday, the highest level relative to the Fed's target rate on record.

``The credit channel is blocked up,'' said Stephen Malyon, co-head of currency strategy in Toronto at Scotia Capital Inc., a unit of Canada's third-largest bank by assets. ``Odds favor the next move by the Fed will be a cut. It surely will hurt the dollar.''

Futures contracts on the Chicago Board of Trade showed an 86 percent chance that the Fed will cut the 2 percent target rate for overnight lending between banks by a quarter-percentage point on Oct. 29, compared with zero chance a month ago.

The dollar has fallen 5.4 percent against the euro since touching a one-year high of $1.3882 on Sept. 11. The dollar reached $1.6038 on July 15, the weakest level since the European currency made its debut in 1999.

To contact the reporters on this story: Stanley White in Tokyo at swhite28@bloomberg.netRon Harui in Singapore at rharui@bloomberg.net