Goldman Expects Yen to Rise 6% Against Dollar on Carry Unwind

By Candice Zachariahs

Nov. 13 (Bloomberg) -- The yen will strengthen 6 percent against the U.S. dollar, and the greenback will advance 4 percent against the euro, because of the unwinding of bets on higher- yielding assets, Goldman Sachs Group Inc. said.

The dollar will weaken to 90 yen in three months, before gaining to 100 yen six months from now, Goldman said. The greenback will trade at $1.20 per euro in three months, before weakening to $1.30 in six months. The previous three-month forecast was for the dollar at 112 yen and $1.45 per euro.

``Deleveraging and funding constraints have likely created a new source of foreign-exchange demand and supply,'' wrote a team of Goldman Sachs analysts including New York-based Jen Nordvig and London-based Thomas Stolper, Fiona Lake and Themistoklis Fiotakis, in a research note. ``We expect deleveraging patterns to continue into year-end, driving the dollar and yen stronger and putting pressure on higher-yielding currencies.''

The yen is the only gainer over the past three months among the 16 most-traded currencies against the greenback, rising 15 percent to 95.67 yen as of 10:06 a.m. in Tokyo. It traded at 119.16 per euro, falling for the first day in three.

The dollar rose for a third day to $1.2455 per euro from $1.2505 yesterday.

Benchmark interest rates of 0.3 percent in Japan and 1 percent in the U.S. prompted investors to use low-cost funds from these countries to invest in higher-yielding assets. Rates are 3.5 percent in the euro region, 12 percent in South Africa, 7.5 percent in India and 5.25 percent in Australia. The risk in such carry trades is that currency market moves will erase profits.

Lehman Collapse

Investors exited bets in higher-yielding assets and fled to the safety of the dollar and yen after the collapse of Lehman Brothers Holdings Inc. on Sept. 15 paralyzed money markets and sent equities tumbling.

The cost of borrowing dollars overnight in London rose to a record 6.88 percent in September before falling to 0.38 percent yesterday after central banks around the world offered financial institutions unlimited dollars to thaw lending. The MSCI World index has plunged 35 percent since September.

``We have been in a multi-year process where leverage has been built,'' wrote the analysts. ``This process is now reversing and is likely to have some inertia, especially now that it has an additional catalyst from pronounced economic weakness.''

The International Monetary Fund this month forecast that the U.S., Japan and Europe will enter their first simultaneous recessions in the post-World War II era. The World Bank expects world trade volumes to contract 2.5 percent in 2009.

`Key Driver'

Past links between foreign-exchange movements and interest- rate differentials, macroeconomic news and balance-of-payment flows have broken, said Goldman. Deleveraging has become the ``key independent driver'' and will continue to ``dominate other forces in the remainder of 2008,'' wrote the Goldman team.

State Street Global Markets estimated in an Oct. 24 report that U.S. investors alone hold $5 trillion of foreign equities.

A widespread recession in the developing world will hurt emerging markets as foreign investors repatriate funds, making it difficult and costly for countries to fund current-account deficits and domestic investments, the Goldman analysts wrote.

Goldman now expects the South African rand, which was trading at 10.3650 per dollar, to slip to 11 per dollar in three months, from a previous call for 9.50. The Indian rupee is now forecast to fall to 50.50 per dollar from an earlier projection of 46.10. Australia's dollar will trade at 64 U.S. cents in three months.

To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net