Dollar May Extend Gain Versus Yen on AIG Bailout Speculation

By Ye Xie

Sept. 17 (Bloomberg) -- The dollar may gain for a second day versus the yen on speculation the Federal Reserve will bail out cash-strapped American International Group Inc.

The U.S. currency rose against the euro for the first time in four days yesterday after the Fed left the target lending rate at 2 percent. The yen fell against the Mexican peso and the New Zealand dollar, reversing earlier gains, on bets an AIG rescue will encourage investors to resume taking out low-cost loans in Japan and buying higher-yielding assets elsewhere.

``Clearly some kind of solution will be very positive,'' said Win Thin, a senior currency strategist at Brown Brothers Harriman & Co. in New York. ``A bit of risk aversion is going away. But the situation is still very fluid.''

The U.S. currency traded at 105.65 yen at 6:20 a.m. in Tokyo, after increasing 1 percent yesterday. The dollar traded at $1.4133 per euro, following a 0.8 percent advance. The yen was at 149.44 per euro, after rising 0.1 percent and earlier touching 147.04, the strongest since August 2006.

The yen gained earlier yesterday versus every other major currency as a debt-rating downgrade of AIG by Standard & Poor's and Moody's Investors Service after the collapse of Lehman Brothers Holdings Inc. fueled concern credit markets are seizing up. Money-market rates surged, with the London interbank offered rate, or Libor, for overnight dollars more than doubling to the highest level in seven years.

`Impressive' Turnaround

``The whole turnaround is very impressive,'' said Brian Dolan, chief currency strategist at FOREX.com, a unit of online trading firm Gain Capital in Bedminster, New Jersey. ``It's like watching a yoyo. This will continue for a while until the fear totally dissipates.''

Implied volatility on one-month dollar-yen options touched 19.26 percent, the highest since March 17, the day before the Fed made a cut in the target lending rate. Volatility of euro- dollar options reached 14.80 percent, the highest since the aftermath of the Sept. 11 terrorist attacks, indicating traders see more price fluctuation in the next month.

The Fed is considering extending a ``loan package'' to AIG, according to a person familiar with the negotiations. The stance by federal regulators is a reversal from a position they held as recently as late Sept. 15, said the person, who declined to be identified because negotiations are confidential. New York Fed spokesman Andrew Williams declined to comment.

The Treasury is considering taking over AIG under a conservatorship as one option to address the insurer's crisis, according to two people briefed on the discussions.

`Too Big to Fail'

``It does suggest some entities are perceived as too big to fail,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``In the short term, if you're long on the yen, you have to cover it quickly. But this crisis has got legs.'' A long position is a bet a currency will rise.

The yen decreased 2 percent to 9.94 against the Mexican peso and 2 percent to 70.37 versus the New Zealand dollar yesterday on speculation a Fed bailout of AIG will encourage investors to put on carry trades, in which they get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's target lending rate of 0.5 percent compares with 8.25 percent in Mexico and 7.5 percent in New Zealand.

Chairman Ben S. Bernanke and his colleagues rebuffed calls by some investors for an interest-rate cut after Lehman filed for bankruptcy, signaling they will continue to address market turmoil with emergency lending and aim monetary policy at a longer-term economic forecast that may still show the economy is skirting a recession.

Fed Speculation

Before the Fed's rate decision was announced, futures on the Chicago Board of Trade indicated an 84 percent chance policy makers would reduce the target rate for overnight lending between banks by a quarter-percentage point. Traders saw a 2 percent chance of a rate cut a week ago.

``Clearly, the risk is the Fed is done cutting rates,'' said Benedikt Germanier, a currency strategist at UBS AG in Stamford, Connecticut. ``The market shows there's no reason to sell the dollar at this stage.''

The Standard & Poor's 500 Index increased 1.8 percent after earlier plunging 2 percent on concern AIG would be the next major financial institution to fail. Lehman filed for the biggest bankruptcy in history Sept. 15 after Bank of America Corp. and Barclays Plc pulled out of talks to buy it.

The dollar has gained about 12 percent since touching an all-time low of $1.6038 per euro on July 15, increasing as the European economy slowed and crude oil dropped 35 percent from its peak of $147.27 a barrel.

To contact the reporter on this story: Ye Xie in New York at yxie6@bloomberg.net