Yen Falls for Second Day Against Dollar After Fed Rescue of AIG

By Ron Harui and Ye Xie

Sept. 17 (Bloomberg) -- The yen fell for a second day versus the dollar after the Federal Reserve said it will lend as much as $85 billion to cash-strapped American International Group Inc. to prevent credit markets seizing up.

Japan's currency also dropped against the Australian and New Zealand dollars on speculation an AIG rescue will encourage investors to resume taking out loans in Japan to buy higher- yielding assets elsewhere. The yen jumped the most in a decade against the greenback on Sept. 15 as mounting credit-market losses forced Lehman Brothers Holdings Inc. to file the biggest bankruptcy in history, causing global stocks to tumble and prompting investors to shun riskier investments.

The Fed's loan is ``likely to support the U.S. financial system and avert a catastrophe,'' said Kenichiro Ikezawa, who helps oversee the equivalent of about $3 billion as a fund manager at Daiwa SB Investments Ltd. in Tokyo. ``Risk-taking appetite will probably recover a bit. Sentiment toward the dollar isn't bad, and the yen may be sold.''

Japan's currency fell 0.6 percent to 106.30 per dollar at 10:49 a.m. in Tokyo, after sliding 0.9 percent yesterday and surging 3.1 percent on Sept. 15. Against the euro, the yen slid 1.1 percent to 150.90. It touched 147.04 yesterday, the strongest since August 2006. The dollar fell 0.5 percent to $1.4193 per euro.

Australia's dollar rose 3.8 percent to 85.48 yen from late in Asia yesterday, and New Zealand's dollar climbed 3.8 percent to 70.46 yen.

``A disorderly failure of AIG could add to already significant levels of financial market fragility and lead to substantially higher borrowing costs, reduced household wealth and materially weaker economic performance,'' the Fed said, explaining its decision to lend money to AIG in return for 79.9 percent stake.

`Impressive' Turnaround

The yen gained earlier yesterday versus all 16 of the most- active currencies as AIG debt-rating downgrades by Standard & Poor's and Moody's Investors Service fueled concern credit- market losses will mount. 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.

``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 19.50 percent yesterday, the highest since March 17, the day before the Fed made a cut in the target lending rate, indicating traders see more price fluctuation in the next month.

`Too Big to Fail'

The Fed's loan to AIG marks a reversal from a position policy makers held as recently as late Sept. 15, said a person with knowledge of the talks, who declined to be identified because negotiations are confidential. New York Fed spokesman Andrew Williams declined to comment.

``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 1.2 percent to 9.857 against the Mexican peso yesterday on speculation a Fed bailout of AIG would encourage investors to put on so-called 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 yesterday 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. The benchmark rate was kept at 2 percent.

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 yesterday closed up 1.8 percent, after earlier plunging 2 percent on concern AIG would be the next major financial institution to fail. Lehman filed for bankruptcy this week 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, strengthening as reports showed the European economy shrank in the second quarter and crude oil dropped more than a third from its peak of $147.27 a barrel.

To contact the reporter on this story: Ron Harui in Tokyo atrharui@bloomberg.net; Ye Xie in New York at yxie6@bloomberg.net