Yen Rises to Two-Year High Against Euro on Downgrade of AIG

By Ye Xie and Bo Nielsen

Sept. 16 (Bloomberg) -- The yen rose to a two-year high against the euro and gained versus the dollar as the debt-rating downgrade of American International Group Inc. fueled concern credit markets are seizing up after the collapse of Lehman Brothers Holdings Inc.

Japan's currency jumped to the highest level in almost five years against the New Zealand dollar as a drop in stocks encouraged investors to reduce holdings of higher-yielding assets and pay back loans in the yen. The dollar rose versus the euro as traders forecast the Federal Reserve will cut interest rates at its meeting today and investors sought a haven.

``The markets are turning upside down,'' said Samarjit Shankar, director of global strategy for the market group in Boston at Bank of New York Mellon, the world's largest custodial bank, with more than $23 trillion in assets. ``Nobody knows what's coming next. Money-market institutions are getting out of risky positions and parking their money in short-term bills denominated in the yen.''

The yen increased 1.2 percent to 147.39 per euro at 10:03 a.m. in New York, from 149.11 yesterday. It touched 147.04, the strongest since August 2006. The Japanese currency climbed 0.9 percent to 103.77 per dollar, from 104.66, after touching 103.54, the strongest since May 27. The dollar increased 0.3 percent to $1.42 per euro, from $1.4243 yesterday, when it reached $1.4481, the weakest level since Sept. 4.

Money-market rates surged today as lending between banks all but seized up. The London interbank offered rate, or Libor, for overnight dollars more than doubled to the highest level in seven years, the British Bankers' Association said.

AIG Downgrade

AIG's credit was downgraded by Standard & Poor's and Moody's Investors Service, threatening efforts to raise emergency funds to keep the company afloat. The largest U.S. insurer by assets is seeking $70 billion to $75 billion in loans arranged by Goldman Sachs Group Inc. and JPMorgan Chase & Co., according to people familiar with the situation.

Lehman filed for the biggest bankruptcy in history yesterday after Bank of America Corp. and Barclays Plc pulled out of talks to buy the New York-based firm.

``It's the end of the world as we know it, at least that is how it feels,'' said Greg Gibbs, a currency strategist at ABN Amro Holding NV in Sydney. ``The main beneficiary has been the yen, which is not a surprise, it being the typical risk-aversion play and given the prospect that Japanese outflow to foreign markets dries up.''

Stronger Yen

The yen gained as much as 2.5 percent to 67.25 against the New Zealand dollar, the strongest level since November 2003, and 3.5 percent to 81.43 versus the Aussie as investors reduced carry trades, in which they borrow where interest rates are low and buy higher-yielding assets elsewhere. Japan's 0.5 percent target lending rate compares with 4.25 percent in Europe, 7 percent in Australia and 7.5 percent in New Zealand.

The Fed added $50 billion in temporary reserves to the banking system with overnight repurchase agreements, or repos, today. It injected $70 billion in reserves yesterday, the most since the Sept. 11, 2001, terrorist attacks.

The Standard & Poor's 500 Index fell 0.9 percent after posting the steepest drop since September 2001 yesterday.

The European Central Bank offered 70 billion euros ($99.8 billion) in a one-day money-market auction today. The Bank of Japan and the Bank of England also injected liquidity to their banking systems. The Libor OIS spread, which measures the availability of funds in the market, increased 15 basis points, or 0.15 percentage point, to 120 basis points today, the widest since at least December 2001.

Money Markets

``All eyes of the currency markets are on the money markets,'' said Steve Barrow, a currency strategist at Standard Bank Plc in London. ``The key issue is whether there is a systemic meltdown in the interbank market. That could cause further dislocations.''

Traders are certain U.S. policy makers will lower the 2 percent target rate for overnight lending between banks when they meet today. Futures on the Chicago Board of Trade showed a 74 percent chance the Fed would reduce the rate by a quarter- percentage point and a 26 percent chance that it would cut by a half-percentage point. Traders saw a 2 percent chance of a rate cut a week ago.

``The market is expecting the Fed to calm things down,'' said Henry Wilkes, head of foreign-exchange trading at Brown Brothers Harriman & Co. in London. ``Whether they actually will is another matter. We're heading into unprecedented waters with the concerns about AIG and the contagion into the insurance market. A lot of people are a bit shell-shocked.''

Implied volatility on one-month euro-dollar options reached 14.71 percent today, the highest level since the aftermath of the Sept. 11 attacks, indicating traders see more price fluctuation in the next month. Volatility on one-month dollar- yen options touched 18.79 percent, the highest since March 17, the day before the Fed cut borrowing costs.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net