Yen Strengthens as Sharper Currency Swings Deter Carry Trades

The yen strengthened against the dollar and the euro as sharper swings in exchange rates prompted traders to cut investments in higher-yielding assets paid for by borrowing the Japanese currency.

The yen was the best performer among the 16 most-active currencies against the dollar today as subprime mortgage losses pushed fund managers to pare so-called carry trades. A measure of volatility in dollar-yen reached the highest in five months.

``The currency market remains choppy and driven by sentiment,'' said Gundy Cahyadi, an economist at IDEAglobal in Singapore. ``Chances the high-yielders will rebound in a big way today will be limited.''

The yen climbed to 162.30 versus the euro at 7:50 a.m. in London compared with 162.58 in late New York yesterday. It also advanced to 118.71 against the dollar from 118.96.

Volatility on one-day dollar-yen options reached 19.005 percent today, the highest since March 14, from 12.755 percent yesterday. Rising volatility may discourage carry trades as it implies bets will be exposed to greater exchange-rate fluctuations.

The yen also advanced 0.3 percent against the Australian and New Zealand dollars, popular carry trade currencies. Australia's dollar was at 101.50 yen from 101.80 yen, and New Zealand's dollar was at 90.85 from 91.15 yen.

The Bank of Japan's 0.5 percent benchmark rate compares with 5.25 percent in the U.S., 8.25 percent in New Zealand and 6.25 percent in Australia.

Repatriation Flows

Japanese investors sold 2.1 billion yen in overseas bonds and notes, while buying 47.4 billion yen in foreign short-term securities, the ministry said. Total holdings were cut for a third week, with net sales of 3.4 billion yen.

The currency also gained on speculation Japanese investors are converting income after Italy paid 14 billion euros ($19.1 billion) in coupon and principal on government debt yesterday, according to Societe Generale SA in Tokyo.

The yen has weakened 3.3 percent against the dollar in the past year as the lowest borrowing costs among major economies encouraged investors to borrow in Japan to buy higher-yielding assets.

American International Group Inc., the world's biggest insurer, may be sitting on losses of as much as $2.3 billion from securities backed by subprime mortgages, analysts said. Bear Stearns Cos., the manager of two hedge funds that collapsed last month, blocked investors from pulling money out of a third fund as losses in the credit markets expand.

``Confidence among investors hasn't clearly been restored, as there are still concerns over the subprime issue,'' said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. ``They're probably looking to scale back carry trades, which may lift the yen'' to 118.40 against the dollar and 161.70 per euro today, he said.

Interest Rates

The euro may be supported by speculation European Central Bank President Jean-Claude Trichet will today signal an interest- rate increase as soon as next month after policy makers keep rates at 4 percent today.

The currency may extend this year's 3.5 percent advance against the dollar as the yield spread between two-year German and U.S. bonds narrowed this week to the least in 2 1/2 years. The British pound may gain for a fourth day as the Bank of England will raise borrowing costs to 6 percent by year-end after holding them at 5.75 percent at today's meeting, a Bloomberg News survey shows.

September Hike

``Trichet is likely to reaffirm expectations of a September rate hike,'' said Masashi Kurabe, currency manager at Bank of Tokyo-Mitsubishi UFJ Ltd. in Tokyo. ``The euro may go higher'' to $1.3720 and 163.50 yen today, he said.

The euro traded at $1.3669 from $1.3667 yesterday, and the pound was at $2.0319 from $2.0325.

Interest-rate futures show investors are betting the ECB will lift rates at least once more this year. The implied yield on the December Euribor futures was at 4.49 percent, up from 4.48 percent yesterday. The contract settles to the three-month interbank offered rate for the euro, which has averaged about 16 basis points above the ECB key rate since 1999.

The dollar may extend losses on speculation a government report tomorrow will show U.S. companies added fewer jobs in July. The Labor Department will report U.S. employers added 127,000 nonfarm jobs, down from 132,000 a month earlier, according to a Bloomberg News survey of economists. The jobless rate is forecast to stay at 4.5 percent.

``Dollar-bearish sentiment is still prevailing amid concern over U.S. subprime issues,'' said Akihiro Tanaka, a senior dealer in Tokyo at Resona Bank Ltd. ``Jobs data won't help boost the dollar, even though data are better than expected. It rather has a further downside risk.''

The dollar may fall to 118.50 yen today, Tanaka said.