As yen carry trade unwinds, U.S. interest rate cut is anticipated

Section:

Yen May Gain for Fourth Day
vs. Dollar, Euro on Sales Data

By Min Zeng
Bloomberg News Service
Wednesday, February 28, 2007

http://www.bloomberg.com/apps/news?pid=20601080&sid=a6BAJ8Esjf4A

NEW YORK -- The yen may rise for a fourth day against the dollar and euro before a government report that is forecast to show retail sales in Japan rebounded last month.

Signs of consumer spending may lift the prospect of an interest-rate increase by the Bank of Japan, pushing investors to exit bets on the yen's decline. The currency gained the most since July 2005 versus the dollar yesterday as investors unwound so-called carry trades, borrowing yen to buy higher-yielding assets elsewhere, following a rout in global stock markets.

"The yen is the favorable currency at the moment," said Michael Woolfolk, senior currency strategist at the Bank of New York in New York. "People are unloading some of the carry trade."

Japan's currency traded at 117.95 against the dollar at 7:02 a.m. in Tokyo from 117.93 yesterday. The yen touched 117.49 per dollar yesterday, the strongest since Dec. 15. It also traded at 156.16 per euro from 156.17, rebounding from an all-time low of 159.65 on Feb. 23.

Retail sales probably rose 2.2 percent last month in Japan, rebounding from a revised 0.1 percent decline in December, according to the median forecast in a Bloomberg survey. The data will be released at 8:50 a.m. Tokyo time.

Japan's central bank raised its benchmark interest rate for the first time in seven months on Feb. 21. Central bank Governor Toshihiko Fukui last week said the bank will gradually raise rates according to developments in the economy and prices.

At 0.5 percent, Japan has the lowest borrowing costs in the industrialized world compared with 5.25 percent in the U.S. and U.K. The European Central Bank's rate is 3.5 percent.

Most Bank of Japan members said they needed to examine more data to confirm the strength of the economy and prices, according to the minutes of its policy meeting last month, released Feb. 26 in Tokyo.

Gains in the yen may be limited as a separate report might show industrial production fell 1.7 percent last month after a 0.9 percent increase in December.

The dollar may extend its decline before reports that are forecast to show the U.S. economy in the fourth quarter grew less than initially reported and new home sales declined last month.

Evidence of slowing growth may boost speculation the Federal Reserve's next move is to cut borrowing costs. The dollar touched a two-month low against the euro yesterday after a report showed U.S. orders for durable goods dropped 7.8 percent in January from a revised 2.8 percent gain a month earlier.

"The overall view is increasingly that U.S. economic growth prospects are diminishing, and the likelihood of a rate cut in the third quarter is increasing," said Brian Dolan, research director at Forex.com, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey. "This is what is generating a dollar-negative bias in the markets."

U.S. gross domestic product last quarter probably advanced at an annual pace of 2.3 percent, down from an initially reported 3.5 percent a month ago, according to a Bloomberg survey. GDP is the broadest measure of all goods and services produced in the U.S. The report is due at 8:30 a.m. Washington time.

New home sales in January probably declined to an annual pace of 1.08 million from 1.12 million a month earlier, a separate report may say at 10 a.m. Washington time.

The odds the Fed will cut interest rates 0.25 percentage point by its meeting in August rose to 100 percent yesterday, from 42 percent a day earlier, according to futures contracts.

The difference in yield between benchmark two-year U.S. and Japanese bonds reached 3.77 percentage points yesterday, the least since Dec. 7.

The dollar traded at $1.3239 per euro from $1.3242 yesterday. It reached $1.3259 yesterday, the lowest since Jan. 3.

The yen rallied yesterday as the decline in U.S. and emerging-market equity markets pushed investors out of riskier assets. The Swiss franc, another funding currency for the carry trade, rose the most in more than three months against the dollar yesterday.

China's shares tumbled the most in 10 years on concern the government may crack down on illegal investments that helped drive benchmarks to records. U.S. stocks plunged, wiping out about $600 billion in market value and erasing all of the year's gains.

"There is a perfect storm brewing against yen carry trade," said Paresh Upadhyaya, who helps manage $29 billion in currency assets at Putnam Investments in Boston. "The yen has further scope to appreciate as people cut back their short yen positions."

A short position is a bet on a currency's decline.

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