Yen Advances as Carry Trades Reverse on Stock Market Declines

By Stanley White and Ron Harui
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Sept. 7 (Bloomberg) -- The yen rose, heading for a weekly gain against 14 of the 16 most-active currencies, as declines in Asian stock markets prompted investors to shun the risk of trades funded with loans in Japan.

The currency rose 2 percent this week against New Zealand's dollar, a favorite of so-called carry trades, after U.S. data showed manufacturing slowed and pending home sales fell the most on record. The yen also gained as losses on mortgages to U.S. homeowners with poor credit sapped demand for riskier investments.

``Stock markets are looking a little heavy and that could give the yen a boost,'' said Osao Iizuka, head of foreign- exchange trading at Sumitomo Trust & Banking Co. in Tokyo. ``There's an established pattern for stock declines contributing to a reversal in carry trades.''

The yen rose to 157.40 per euro at 7:55 a.m. in London from 157.95 late yesterday in New York. It also gained to 115.12 against the dollar from 115.38 yesterday. The yen may rise to 114.70 a dollar today, Iizuka said.

The Nikkei 225 Stock Average fell 0.8 percent today and 2.7 percent this week. The Morgan Stanley Capital International Asia- Pacific Index of regional shares declined 0.3 percent today and S&P 500 futures slid 3.4 points to 1,476.20.

Japan's benchmark stock measure has a correlation of 0.84 with the dollar-yen this year, while the S&P 500's is 0.61. A reading of 1 would mean equities and currencies moved in lockstep.

Japan's currency rose 0.6 percent versus the euro Sept. 5 as the Nikkei 225 fell 1.6 percent, the largest drop since Aug. 29.

The Bank of Japan's key rate of 0.5 percent, the lowest in the industrialized world, compared with benchmark rates of 8.25 percent in New Zealand and 6.50 percent in Australia.

Predicting Gains

New Zealand's dollar traded at 79.64 yen from 79.91 yesterday and 81.23 a week earlier. Australia's dollar, another carry-trade favorite, was at 95.23 yen from 95.66 yesterday and 94.76 last week.

In a carry trade, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency market moves erase those profits.

The yen may gain more than 10 percent and still not hurt growth in the world's second-largest economy, said Eisuke Sakakibara, Japan's former top currency official.

``Even if Japan's currency rises to more than 100 yen, it wouldn't hurt economic fundamentals'' because the corporate sector is strong enough to compete in the global market, Sakakibara, 66, said in a Sept. 5 interview in Tokyo.

`Reduce Capital Outflows'

Barclays Capital raised its year-end forecast for the yen to 109 from 114, predicting it will rise to the strongest against the dollar since May 2006, as Japanese individual investors reduce sales.

``Investors are likely to continue to try to reduce their exposure to risk,'' said Toru Umemoto, chief currency strategist at Barclays Capital in Tokyo, in an interview today. ``This is likely to reduce capital outflows by Japanese investors as they unwind their short yen exposure.'' A short position is a wager on a currency's decline.

The dollar headed for a weekly decline against the euro on speculation the U.S. subprime-mortgage crisis will prompt the Federal Reserve to lower interest rates this month.

Growth Penalty

The U.S. currency may drop for a third day versus the euro after Federal Deposit Insurance Corp. Chairman Sheila Bair said yesterday an additional 1.5 million subprime borrowers may fall behind with repayments. The yield advantage for holding U.S. two- year debt over similar maturity German bunds narrowed to zero this week, for the first time since September 2004.

``The markets are wary of weak jobs data,'' said Tomoko Fujii, head of economics and strategy for Japan at Bank of America N.A. in Tokyo. ``The dollar has further downside risk.''

The dollar may drop to $1.3900 by year-end, from $1.3667, according to a Bank of America research note published Sept. 5.

Treasury Secretary Henry Paulson yesterday told PBS Television's ``Nightly Business Report'' it may take a number of months to work out the strains in capital markets and ``there will be a penalty to our economic growth.''

Interest-rate futures show traders are betting with 100 percent certainty the Fed will lower borrowing costs by at least a quarter-percentage point to 5 percent on Sept. 18.

The U.S. currency headed for a second weekly loss against the yen as a government report today may show the pace of job creation held near the slowest this year. Nonfarm payrolls will be 100,000 in August, from 92,000 in July, according to a Bloomberg News survey of economists, compared with a monthly average of 186,000 the past three years.

Last Updated: September 7, 2007 02:55 EDT