Yen Set for Biggest Gain in 10 Years as Carry Trade Evaporates

By Daniel Kruger and Kim-Mai Cutler

Oct. 10 (Bloomberg) -- The yen headed for its biggest weekly gain in a decade against the dollar as the global stock- market rout prompted investors to sell higher-yielding assets and pay back low-cost loans in Japan.

Japan's currency was poised to rise the most versus the euro in any week since the 15-nation euro's debut in 1999 as a plunge in global stocks discouraged carry trades. President George W. Bush said the U.S. is working with global partners to solve the financial crisis as Group of Seven finance ministers and central bankers met today in Washington.

``Investors are concerned it could get worse,'' said JensNordvig, a currency strategist at Goldman Sachs Group Inc. in New York. ``Clearly a lot of investors have only one goal, to preserve capital.''

The yen traded at 99.96 per dollar at 10:48 a.m. in New York, compared with 99.82 yesterday, after reaching 97.92, the strongest level since March 19. Japan's currency advanced 0.4 percent to 135.35 per euro, from 135.83. It touched 132.83, the strongest level since July 2005. The euro fell 0.5 percent to $1.3531, from $1.3604.

The U.S. currency has dropped 5.2 percent against the yen this week, the most since Oct. 9, 1998, when it plunged 14 percent as investors shed risk and abandoned yen carry trades in the wake of the collapse of hedge fund Long-Term Capital Management LP.

Coordinated interest-rate reductions by central banks in the U.S., Europe and Asia in the past two days failed to revive lending among banks, putting stocks on course for their worst week in 30 years. The cost of borrowing in dollars in London for three months rose to 4.82 percent today, the highest since December, the British Bankers' Association said.

G-7 Alternatives

Threatened by the worst economic outlook in a quarter- century, G-7 officials arrived in Washington without a broad- based strategy that investors were seeking. Among options is a proposal by U.K. Chancellor Alistair Darling for nations to guarantee lending between banks, a suggestion that U.S. Treasury Secretary Henry Paulson hasn't ruled out.

``I don't think this particular G-7 meeting will rewrite history,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York. ``I'm not optimistic anything material will come out.''

Paulson and Federal Reserve Chairman Ben S. Bernanke will meet with counterparts from the G-7, which comprises Canada, France, Germany, Italy, the U.K., the U.S. and Japan. Paulson and top aides are still considering options on how to proceed with a $700 billion bank bailout plan, including having the government acquire preferred stock, two officials informed of the matter said.

Euro vs. Dollar

Europe's currency is on course for its second straight weekly decline versus the dollar on speculation the credit crisis in Europe will deepen, prompting the European Central Bank to cut interest rates further. The bank lowered its main refinancing rate two days ago for the first time in five years. The pound fell as much as 1.8 percent to $1.6792, breaching $1.70 for the first time since November 2003.

The South Korean won surged as much as 11 percent to 1,224.95 per dollar after a meeting among financial regulators fueled speculation the government will intervene to support the currency, which reached a decade-low of 1,485.32 yesterday. The nation's foreign-exchange reserves dropped in each of the past six months, sliding $24.6 billion to $239.7 billion as the Bank of Korea used the funds to stem the won's slide.

Stronger Yen

The yen gained 20 percent this week to 65.55 versus the Australian dollar, 15.4 percent to 58.97 against New Zealand's currency, known as the kiwi, and 7.6 percent against the euro on speculation investors will reverse trades in which they get funds in countries with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 6 percent in Australia, 7.5 percent in New Zealand and 3.75 percent in Europe.

``It has been most volatile against the Aussie and kiwi, and the big move is to the downside,'' said Derek Halpenny, the European head of global currency research at Bank of Tokyo- Mitsubishi Ltd. in London. ``If you stand back from this, the moves we have seen are extreme. We should continue to see the yen as the star performer.''

Implied volatility on one-month dollar-yen options, a measure of expectations for future currency moves, rose to 32.18 percent, the highest since Bloomberg began compiling the data in 1996. Higher volatility can wipe out carry trade profits.

``People in the options market are saying this is some of the most frantic activity they have seen,'' said Geoffrey Yu, a foreign-exchange strategist in London at UBS AG, the second- biggest currency trader. ``You don't want outright cash exposure to the yen because it's so volatile. That's why people are going into options.''

Currency volatility mirrored turbulence in global stock markets as the VIX, the Chicago Board Options Exchange Volatility Index surpassed 60 for the first time yesterday. The VIX jumped 11 percent to 63.92. The Standard & Poor's 500 Index dropped for an eighth day today, falling 3 percent, in its longest losing streak since 1996.

To contact the reporters on this story: Daniel Kruger in New York at dkruger1@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net