By Stanley White
Sept. 22 (Bloomberg) -- The dollar dropped against the yen for the first time in three days on concern a U.S. government plan to buy $700 billion of troubled assets from banks will widen the country's budget deficit.
The currency reached a three-week low against the euro before reports this week that will probably show tighter lending rules contributed to a drop in U.S. home sales and durable goods orders. The greenback also fell against the Swiss franc as two- year Treasury yields declined for the first time in three days on bets the Federal Reserve will cut interest rates.
``Problems with the U.S. deficit will haunt the dollar,'' said Masanobu Ishikawa, general manager of foreign exchange at Tokyo Forex & Ueda Harlow Ltd., Japan's largest currency broker. ``Spending such a large amount on this rescue package will remind traders that the fiscal health of the U.S. is set to worsen.''
The dollar fell to 106.55 yen as of 7:04 a.m. in London, from 107.45 in New York late on Sept. 19. The U.S. currency declined to $1.4563 per euro, the lowest since Sept. 2, and traded at $1.4483 from $1.4466. The dollar declined to 1.1028 Swiss francs from 1.1054. The euro bought 154.40 yen from 155.46 yen. The dollar may reach 106.30 yen today, Ishikawa said.
Treasury Secretary Henry Paulson's plan, sent to Congress Sept. 20, would mark an unprecedented government intrusion into markets and increase the nation's debt ceiling by 6.6 percent to $11.315 trillion. Officials may also provide $400 billion of guarantees for money-market funds.
The rescue plan will boost U.S. borrowing as much as $1 trillion, according to Barclays Capital interest-rate strategist Michael Pond in New York. The Congressional Budget Office projects the budget deficit will increase to $438 billion next year from $407 billion.
`Crushed'
``As we get to the other side of this, the dollar will get crushed,'' said John Taylor, chairman of New York-based International Foreign Exchange Concepts Inc., the world's biggest currency hedge-fund firm, which manages about $15 billion.
The bailout may end a dollar rally that began in June and drove the U.S. currency up 10 percent versus the euro, 2 percent against the yen and almost 13 percent compared with Brazil's real, strategists said.
Paulson and Federal Reserve Chairman Ben S. Bernanke began plotting the rescue last week after New York-based Lehman Brothers Holdings Inc. filed for bankruptcy, the government seized control of American International Group Inc. and Merrill Lynch & Co. was forced into the arms of Bank of America Corp.
Dollar Downdraft
``The downdraft on the dollar from the hit to the balance sheet of the U.S. government will dwarf the short-term gains from solving the banking crisis,'' said David Woo, London-based global head of foreign-exchange strategy at Barclays Capital, the third-biggest currency trader.
The dollar also fell as two-year Treasury yields dropped 7 basis points to 2.12 percent on speculation the Fed will cut rates as soon as next month. Paulson and Bernanke are due to testify before the Senate tomorrow about the banking crisis.
The chances of the Fed cutting its benchmark 2 percent rate by a quarter-percentage point at an Oct. 29 policy meeting stood at 32 percent, up from zero a month ago, futures contracts on the Chicago Board of Trade show.
Housing, Durable Goods
Home resales declined to 4.94 million from 5 million in July, according to a Bloomberg News survey before the National Association of Realtors' report on Sept. 24. A day later, the Commerce Department is forecast to report sales of new houses dropped to 510,000 from 515,000 in July, according to a separate survey. Orders for durable goods fell 1.8 percent in August from a 1.3 percent rise in the previous month, another survey shows. The data are due Sept. 25.
The yen rose to 88.43 against the Australian dollar from 89.60 and gained 1.4 percent versus the New Zealand dollar to 73.02 as the U.S. bailout plan failed to ease concern about a global economic slump, prompting traders to pare holdings of higher-yielding assets funded with the Japanese currency.
Carry Trades
In carry trades, investors get funds in a country with low borrowing costs and invest in another with higher interest rates, earning the spread between the two. The risk is that currency market moves can erase those profits.
The Bank of Japan's benchmark rate of 0.5 percent compares with 4.25 percent in Europe, 7 percent in Australia and 7.5 percent in New Zealand.
``The yen may be bought back,'' said Takeshi Iba, vice president of foreign exchange in Tokyo at BBH Investment Services Inc., a unit of Brown Brothers Harriman. ``We still don't know how Congress will deal with this rescue package and how well this plan will work.''
The yen may rise to 106 per dollar today, he said.
Implied volatility for dollar-yen options expiring in one month rose to 16.48 percent from 16 percent late on Sept. 19 on speculation currency markets will face wider swings as banks remain reluctant to lend to each other, said Takeharu Miki, currency options manager at Bank of Tokyo-Mitsubishi UFJ Ltd.
Dealers traded $50 million to $100 million of so-called straddles that expire in two months with an implied volatility of 15 percent and a strike price near the dollar's current level, Miki said.
Holders of straddles, which are call and put options with the same strike and duration, benefit if the underlying currency moves in either direction. Calls grant the right to buy, while puts allow for sales. Dealers quote implied volatility as part of pricing options.
``Options market makers hesitate to sell volatility,'' said Miki of Bank of Tokyo-Mitsubishi UFJ, a unit of Japan's biggest lender by assets. ``There's just too much event risk.''
To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net
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