Yen May Rise Versus Euro as Writedowns Spur Cuts in Carry Trade

By Bo Nielsen


Nov. 6 (Bloomberg) -- The yen may rise versus the euro as writedowns on subprime-related assets might prompt traders to pare investments bought with money borrowed in Japan.

The Japanese yen may gain against high-yielding currencies such as the Australian and New Zealand dollars, favorites of so- called carry trades, after risk aversion rose when Citigroup Inc. said it might write down as much as $11 billion.

``The news out of the U.S. financial sector will continue to be bearish for corporate earnings and equities, and give the yen some support,'' said Alan Kabbani, senior currency trader at Wachovia Corp. in Charlotte, North Carolina.

The yen traded at 114.55 against the dollar and 165.72 versus the euro at 7 a.m. in Tokyo. The currency gained 0.6 percent against the euro, 0.3 percent versus the U.S. dollar and 0.6 percent against Australia's dollar yesterday.

Japan's currency will reach 114 per dollar at the end of March, according to the median forecast of 42 analysts and brokerages surveyed by Bloomberg News.

Implied volatility on dollar-yen currency options expiring in one month yesterday rose to 10.1 percent from 8.9 percent on Nov. 2. Higher volatility may discourage carry trades as it exposes these bets to more currency risk.

Carry Trades

In carry trades, investors borrow in a country with low interest rates and invest in one with higher borrowing costs, profiting on the difference. Japan's rate of 0.5 percent is the lowest among major economies and compares with 8.25 percent in New Zealand. The Australian central bank is forecast to boost borrowing costs to 6.75 percent, according to all 27 economists surveyed by Bloomberg.

The option 25 delta one month risk-reversal rate, used as an indicator of sentiment in the foreign-exchange market, shows traders are more bullish on the yen than any of the 16 most- traded currencies tracked on that basis by Bloomberg. The rate against the New Zealand dollar of minus 3.3 indicates traders will pay a premium for a call option, gaining when a currency rises, over a put, which gains when a currency weakens.

The difference in the number of wagers by hedge funds and other large speculators on a decline in the yen compared with those on a gain -- so-called net shorts -- dropped more than 50 percent to 9,949 on Oct. 30 from a week earlier, according to data from the Commodity Futures Trading Commission in Washington.

Risk aversion rose after Citigroup Chairman and Chief Executive Officer Charles Prince resigned as the biggest U.S. bank by assets said subprime mortgages and related securities lost as much as $11 billion of their value in the past month, a decline that may wipe out half of the company's profit so far this year.

Merrill Lynch & Co., the world's biggest brokerage, ousted Chairman and CEO Stan O'Neal last week, after the New York-based firm disclosed $8.4 billion of writedowns.

`Markets Twitching'

``You have got the markets twitching over the added risk from the U.S. financial sector,'' said Alan Ruskin, head of international currency strategy at RBS Greenwich Capital Markets in Greenwich, Connecticut.

Japan's broadest indicator of the outlook for economic growth fell to 0 percent for September, the lowest since December 1997, according to all 28 economists surveyed by Bloomberg News. A reading below 50 signals the economy may slow in three to six months. The data will be released at 2 p.m. in Tokyo.

Bank of Japan Governor Toshihiko Fukui yesterday said the country's ``very low'' borrowing costs should be raised gradually.

``Keeping interest rates lower than the economy's strength is risky,'' Fukui told business executives in Osaka. ``Interest rates need to be increased in a timely manner.''

None of the 25 economists surveyed by Bloomberg forecast a change in monetary policy this month by the BOJ.