Dollar Weakens Against Euro, Yen as Lehman Files for Bankruptcy

By Bo Nielsen and Ron Harui

Sept. 15 (Bloomberg) -- The dollar dropped against the euro and 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 dropped to its lowest in almost two months against the yen, and the Swiss franc surged, as American International Group Inc. sought capital to avoid credit downgrades. The dollar pared declines after Bank of America Corp. agreed to acquire Merrill Lynch & Co. and as investors sought the relative safety of U.S. Treasuries.

``The dollar will weaken on concern over the U.S. financial system and on the potential for an emergency rate cut tomorrow,'' 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 declined to $1.4481, the lowest since Sept. 4, before trading at $1.4302 per euro at 8:30 a.m. in London, from $1.4224 in New York late last week. It touched $1.3882 on Sept. 11, the strongest since Sept. 18, 2007. The U.S. currency dropped 2.2 percent to 105.62 yen. It earlier reached 105.27 yen, the lowest since July 17.

The U.S. currency fell against all 16 most-active currencies today as Lehman filed a Chapter 11 petition in the U.S. Bankruptcy Court for the Southern District of New York. The currency is headed for the biggest one-day decline since Aug. 16, 2007, when a global stock rout prompted investors to reduce so-called carry trades.

Dollar Index

The ICE's Dollar Index, a gauge measuring the dollar against currencies of six U.S. trading partners, slipped 0.7 percent to 78.383 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.

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

The dollar also declined as the implied yield on federal funds futures contracts for December delivery slid 16 basis points to 1.75 percent, a quarter-percentage point less than the Fed's target rate. The last time the deficit was so large was in April before the central bank cut the rate by a quarter point on the last day of the month.

Futures on the Chicago Board of Trade showed late last week a 12 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.

`Safe-Haven Flows'

``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.''

The yield on the two-year Treasury dropped 35 basis points to 1.85 percent, the first time is has fallen below 2 percent since April, as investors sold higher-yielding assets.

The Swiss franc, which typically gains when trader aversion to higher-risk investments increases, rose 1.5 percent to 1.1136 per dollar, the biggest gain since June 5.

Stocks tumbled, with Standard & Poor's 500 Index futures expiring in December snapping three days of gains to slide 3.3 percent. The MSCI Asia-Pacific Index of regional shares excluding Japan declined 1.6 percent. Markets in China, Hong Kong, Japan and South Korea were shut for holidays today.

Risk Aversion

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.

The yen advanced against all of the 16 major currencies as investors reduced so-called carry trades, in which 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.

The benchmark interest rate of 0.5 percent in Japan compares with 4.25 percent in the 15-nation euro region, making the yen a favorite funding currency for the carry trade.

The Australian dollar slid 2 percent to 87.19 yen and New Zealand's dollar dropped 1.7 percent to 70.90 yen, both approaching two-year lows against Japan's currency.

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