Yen Advances Most in Decade Against Dollar on Lehman Bankruptcy

By Bo Nielsen

Sept. 15 (Bloomberg) -- The yen strengthened the most in 10 years against the dollar after Lehman Brothers Holdings Inc. filed for bankruptcy, prompting traders to sell assets financed with loans in Japan.

The Japanese currency also climbed to its strongest in two years versus the euro as American International Group Inc. failed to present a plan to raise capital and avoid credit downgrades. The Swiss franc rose against every major currency except the yen as investors reversed so-called carry trades.

``This is momentous, it's hard to imagine anything more cataclysmic than this,'' said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut. ``It will be hard to top that kind of news flow. The yen hasn't looked so good for quite a while.''

The yen gained as much as 3.4 percent to 104.54 per dollar, the most since October 1998, and traded at 105.71 at 9:55 a.m. in New York, from 107.94 on Sept. 12. The U.S. currency was at $1.4193 per euro, from $1.4224, after weakening to $1.4481 earlier. It touched $1.3882 on Sept. 11, the strongest since Sept. 18, 2007.

The Japanese currency surged 2.3 percent to 149.88 per euro and rallied against all 16 major currencies as investors reduced carry trades. In such transactions, traders borrow in low- yielding countries such as Switzerland and Japan to buy higher- yielding assets elsewhere. They earn the spread between the two, taking the risk that currency moves erase their profit.

The yen may strengthen to 1.40 per euro in three months, Ruskin said.

`Yen Will Strengthen'

The Australian dollar fell 4.1 percent to 85.24 yen, the biggest drop since November, and New Zealand's dollar declined 3.5 percent to 69.54 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, Australia's is 7 percent and New Zealand's 7.5 percent.

Lehman filed a Chapter 11 petition in the U.S. Bankruptcy Court for the Southern District of New York after Bank of America Corp. and Barclays Plc pulled out of talks to buy the New York-based bank.

AIG, trying to stave off credit downgrades that would force it to post more than $13 billion in collateral, asked the Federal Reserve for a $40 billion bridge loan after rejecting an offer from J.C. Flowers & Co., the New York Times reported, citing an unidentified person.

``The yen will strengthen on the back of this news,'' said Ian Stannard, a senior currency strategist at BNP Paribas SA in London. ``Risk reduction is the theme.'' The dollar may trade as low as 101 yen in the coming weeks, he said.

Merrill Lynch

The U.S. currency rose against the euro after Bank of America agreed to acquire Merrill Lynch & Co. for $50 billion, reducing the risk of financial collapse, and as investors sought the relative safety of U.S. Treasuries.

The ICE's Dollar Index, a gauge measuring the dollar against the currencies of six U.S. trading partners, slipped as much as 1.7 percent to 77.642 on concern that credit-market losses will spread to other financial institutions. It was last unchanged at 78.935.

``I expect dollar strength to be the core theme of the day,'' said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. ``People move back into cash and the dollar on safe-haven flows.''

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

Swiss Franc

The dollar weakened as expectations for a Fed rate cut surged. Futures on the Chicago Board of Trade showed an 64 percent chance the central bank will lower its 2 percent target rate for overnight lending between banks by a quarter-percentage point tomorrow, compared with no chance a week ago.

The Swiss franc, which typically strengthens when trader aversion to higher-risk investments increases, rose as much as 1.3 percent, the biggest gain since June 6, before trading at 1.1216 from 1.1305 on Sept. 12. Switzerland's benchmark rate of 2.75 percent is the lowest among the biggest economies after Japan, whose key rates is 0.5 percent.

Stocks tumbled, with Standard & Poor's 500 Index falling 2.5 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 cut interest rates for the first time in six years and allowed most banks to set aside smaller reserves as worsening credit-market turmoil and weakening export demand dim the outlook for economic growth.

The People's Bank of China reduced the one-year lending rate to 7.20 percent from 7.47 percent, effective tomorrow, and lowered the reserve ratio at the nation's smaller banks by 1 percentage point. The changes were in a statement on the central bank's Web site today.

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net