Yen Volatility Rises; Financing Difficulties Dim Risk Appetite

Sept. 10 -- The yen is the most volatile it's been this month as investors trim risky bets on speculation banks and companies will have trouble refinancing almost $140 billion of commercial paper maturing in Europe by the end of next week.

Rising corporate funding costs have made investors more risk averse, spurring sales of stocks and other assets purchased with borrowed yen, as part of the so-called carry trade. Stocks in the U.S. and Europe fell today. Borrowers are paying the highest costs in six years to sell commercial paper, which are IOUs maturing in 270 days or less, because of losses on assets related to subprime mortgages.

``There has been a strong connection between volatility in other assets classes, like equities, and yen volatility,'' said Chris Turner, head of currency research at ING Financial Markets in London. ``As equities go down and volatility rises in general it makes a less favorable environment for the carry trade.''

Volatility on one-month options on the U.S. dollar-yen exchange rate rose to 14.55 percent, from 13 percent on Sept. 7, and touched the highest since Aug. 30. So-called implied volatility reached 23.50 percent on Aug. 17, the highest since 1999. Traders quote implied volatility, a gauge of expectations of currency swings, as part of setting options prices.

Exchange Rate Swings

In carry trades, investors borrow in Japan, where the benchmark overnight rate is 0.5 percent, to buy assets where yields are higher. The U.S.'s key rate is 5.25 percent. Investors seek to earn the spread between the borrowing and lending rate. The risk is that currency moves erase those profits.

Swings in the yen's exchange rate have increased as the yen has rallied. Investors exiting bets the yen would fall drove the currency to a 14-month high of 111.61 per dollar on Aug. 17. The yen traded at 113.49 per dollar today.

Banks and companies need to refinance almost $140 billion of commercial paper in Europe by the end of next week, according to Deutsche Bank AG, Germany's biggest bank. Almost $60 billion of the total due is owed by conduits, firms set up by banks and companies to invest in longer-term assets, according to Deutsche. The debt is backed by bonds including asset-backed securities, as well as car loans, mortgages and trade receivables. The rest is unsecured.

In the U.S., investors have shunned asset-backed commercial paper for Treasuries. The U.S. commercial paper market shrank for a fourth week last week, according to Federal Reserve data.

The three-month London interbank offered rate, or Libor, for dollars dropped 2 basis points from a seven-year high today to 5.70 percent, the first decline in 13 days, according to the British Bankers' Association. A basis point is 0.01 percentage point.

``Movements in equities are a big factor in the currency markets now,'' said Harwig Wild, a currency strategist at Bankhaus Metzler in Frankfurt. ``Foreign-exchange volatility will remain high in the market for quite some time.''

By Liz Capo McCormick (Bloomberg)

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