Yen Declines From Three-Year High Against Euro as Stocks Rally

By Ye Xie

Oct. 18 (Bloomberg) -- The yen fell from a three-year high against the euro and dropped versus the dollar as a rally in U.S. stocks renewed speculation investors will buy higher- yielding assets funded by low-cost loans in Japan.

Japan's currency also fell this week versus the Brazilian real and the Australian dollar as a drop in short-term borrowing costs among banks indicated the credit market may be thawing, spurring demand for carry trades. The real and the Mexican peso rose against the dollar on bets the U.S. bailout of financial firms will reduce aversion to emerging-market assets.

``The yen is reflective of the slight improvement of sentiment in financial markets,'' said Carl Forcheski, vice president on the corporate currency sales desk at Societe Generale SA in New York. ``It's too early to sound all clear. Volatility will be with us for quite some time.''

The yen weakened 0.95 percent to 136.24 per euro yesterday, from 134.96, on Oct. 10, when it touched 132.24, the strongest level since June 2005. Japan's currency dropped 1 percent to 101.69 per dollar from 100.67. The euro was little changed at $1.341 from $1.3408.

The Standard & Poor's 500 Index rose 4.6 percent this week after losing 18 percent the prior week in its worst loss in 75 years. Billionaire investor Warren Buffett, writing yesterday in the New York Times, said he's buying U.S. stocks.

Brazil's real climbed 9.2 percent this week to 2.1190 per dollar after sinking 11.7 percent last week and 9.8 percent the previous week. The Mexican peso increased 1.7 percent to 12.88 against the dollar after seven weeks of declines.

Gross on Confidence

Government efforts worldwide may soon begin to restore investor confidence, said billionaire Bill Gross, who manages the world's biggest bond fund at Pacific Investment Management Co., in an interview on Bloomberg Radio yesterday.

In a sign credit market stress may be easing, the cost of borrowing dollars fell this week. The London interbank offered rate, or Libor, for three-month loans in dollars dropped 40 basis points, or 0.40 percentage point, to 4.42 percent, the British Bankers' Association said. The overnight rate for dollars slid 80 basis points this week to 1.67 percent, the lowest level since September 2004.

The U.S. Treasury announced on Oct. 14 a plan to inject $250 billion into financial institutions a day after European governments committed $1.8 trillion to guarantee loans and invest in lenders.

Japan's currency declined 8.1 percent this week to 70.06 against the Aussie and 10.3 percent to 47.99 versus the real on bets investors will resume carry trades, in which they get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target rate compares with 6 percent in Australia and 13.75 percent in Brazil.

Reduced Volatility

Implied volatility in one-month dollar-yen options fell to 20.4 percent, from 29.6 percent a week earlier, indicating traders see less price fluctuation in the coming month. Reduced volatility tends to work in favor of carry trades by making profit from bets on interest-rate differences more predictable.

``Those people who kept their powder dry may find it's not a bad opportunity to get into the carry trade again,'' said Dave Floyd, global head of foreign-exchange research and trading in Bend, Oregon, at Aspen Trading Group, a research and trading firm. ``The lack of downward momentum in yen crosses suggests we are in a transitional phase from higher volatility to relatively low volatility.''

In the past month, the yen has gained 15.4 percent versus the real and 18.1 percent against the Aussie as the logjam in credit encouraged the unwinding of carry trades.

Yen Crosses

``I am not quite sure if we're getting a reversal in sentiment, but in the short term, the yen crosses move more quickly when they shoot up than when they come down,'' said Matthew Kassel, director of proprietary trading at ING Financial Markets LLC in New York.

The Conference Board's index of leading indicators, which points to the direction of the economy over the next three to six months, probably fell 0.1 percent in September, after dropping 0.5 percent in the previous month, according to the median forecast of 36 economists surveyed by Bloomberg News. The report is scheduled to be released Oct. 20.

The yen may appreciate to 100 per dollar ``easily,'' as the U.S. economy falls into a recession, according to Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank Ltd. in New York.

``If you look at the state of the economy and corporate America, we are going to be in a fairly tough situation for quite some time,'' he said. ``The dollar will be under pressure mainly against the yen. The yen will be the strongest currency going forward.''

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