Wednesday, December 12, 2007

Yen May Extend Drop as Central Banks Move to Ease Credit Crunch

By Min Zeng and Bo Nielsen

Dec. 13 (Bloomberg) -- The yen may extend a decline against major currencies after central banks led by the Federal Reserve announced a joint effort to ease the credit squeeze by encouraging short-term lending among financial institutions.

The central banks' move prompted investors to resume using yen-denominated loans to buy higher-yielding assets in other countries, in a bet bank lending will pick up and the U.S. economy will avoid a recession. Currencies in New Zealand and South Africa led gains against the yen yesterday.

``This is a step in the right direction,'' said Michael Malpede, a senior currency analyst in Chicago at MF Global Research, part of MF Global Ltd., the world's largest broker of exchange-traded futures and options contacts. ``The fact that global central banks joined together to provide liquidity is injecting confidence in the market, fueling investors to buy higher-yielding assets.''

The yen traded at 112.07 per dollar at 7:19 a.m. in Tokyo, after a 1.4 percent decline yesterday, its steepest in two weeks. Japan's currency traded at 164.82 per euro, following yesterday's 1.8 percent drop, its largest in a month. The dollar traded at $1.4707 per euro.

Yesterday's drop in the yen eclipsed a rally on Dec. 11 when traders dumped stocks and higher-yielding currencies on speculation the Fed's interest-rate cuts weren't enough to keep the economy from contracting.

Funding `Squeeze'

The currencies of New Zealand, South Africa and Australia gained about 2 percent or greater versus the yen yesterday as investors returned to so-called carry trades. Against the dollar, the New Zealand currency rose 2 percent while the Australian currency strengthened 1 percent.

The Fed will provide cash to banks through up to $40 billion in two auctions this month and will provide $24 billion in currency swap lines to the European and Swiss central banks.

``It will help allay the squeeze we have seen in the funding market,'' said Karen Chen, a currency portfolio manager in New York at Fischer Francis Trees & Watts, with $32 billion in assets. ``There is no reason to own the yen right now.''

The Fed on Dec. 11 lowered its benchmark overnight rate a quarter-percentage point to 4.25 percent, in line with the median forecast in a Bloomberg survey. It dropped the discount rate, the rate it charges banks for direct loans, by a quarter- point to 4.75 percent. Some analysts had called for a larger discount rate cut to counter the drop in bank lending.

Franc Drops

The Standard & Poor's 500 index rose 0.6 percent, paring a gain of as much as 2.3 percent earlier. The index sank 2.5 percent on Dec. 11. Treasuries fell as demand for the safety of government debt diminished. Crude oil surged 4.8 percent on speculation the central banks' actions will spur global growth.

The Swiss franc, another funding currency for the carry trade, fell against all 16 major currencies except the yen.

``There's a restored confidence in the market,'' said Mark Meadows, strategist at currency-trading company Tempus Consulting Inc. in Washington. ``The Fed is making a lot of moves to ensure the U.S. economy doesn't decline substantially.''

In carry trades, investors get funds in a country with low borrowing costs and buy assets where rates are higher, earning the difference. The risk in this strategy is that exchange-rate swings erode gains from yield differentials.

Wider Yield Difference

The Bank of Japan's benchmark rate is 0.5 percent, the lowest among industrialized nations, compared with 8.25 percent in New Zealand and 6.75 percent in Australia. Switzerland's rate is 2.75 percent.

The U.S. currency has lost 10 percent against the euro this year as the Fed's rate cuts dimmed the allure of dollar- denominated assets. Two-year German government debt yielded 0.90 percentage point more than similar-maturity Treasuries. The gap reached 0.98 percentage point this week, the widest since 2003.

The move by the Fed, the ECB, the Bank of Canada, the Bank of England and the Swiss National Bank comes as the collapse in the subprime mortgage market has crimped banks' willingness to lend to each other, threatening to tip the U.S. economy into recession.

The Fed's first auction of term funds will be $20 billion on Dec. 17. The second, on Dec. 20, will provide up to $20 billion. The central bank plans two more auctions in January, with possible additional operations thereafter, the Fed said.

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