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Dollar, Euro Rally Against Yen as Stocks Extend Gains

The yen hit a 2-1/2-week low against the euro and dipped against the dollar on Monday as a
rash of corporate merger news bolstered global stock markets, reviving investors' appetite for risk.

The yen had gained in recent weeks as stock prices fell, which caused investors to shy away from risky trades often financed with the Japanese currency.

Known as carry trades, these dealings involve borrowing yen or Swiss francs at low interest rates to invest in assets and regions offering higher returns -- and often higher risk.

Rising defaults in the U.S. subprime mortgage sector have also dulled risk appetite, but a flurry of corporate deals on Monday sparked a broad recovery in global equities.

That lured investors back into into carry trades, pushing the high-yield Australian dollar just short of its highest level in a decade.

"Once the equity market begins to rebound, people want to put risk back on," said Andrew Busch, global foreign exchange strategist at BMO Capital Markets in Chicago. "We have seen them buying sterling, the South African rand, New Zealand (dollar) and selling yen."

Analysts said they did not expect the euro to rise higher than 157.50 yen, predicting a 152.50-157.50 range against the Japanese currency in the near term.

The U.S. currency eased a touch after a decline in the NAHB/Wells Fargo Housing Market index on Monday, but the move was seen as marginal.

On Friday, fears that the U.S. subprime mortgage crisis could hurt the broader economy and prompt the Federal Reserve to cut interest rates sent the dollar to a three-month low against a basket of currencies.

Stephen Jen, currency strategist at Morgan Stanley in London, said solid global growth should prompt investors to continue wading back into riskier trades.

"I think the financial markets have been temporarily out of sync with the real economy," he wrote in a note to clients, adding he expects the dollar to extend gains against the yen.

China Surprise

The yen earlier rose after China delivered a surprise interest rate rise designed to trim credit and investment growth in the world's fourth-largest economy. The yen often trades as a proxy for the tightly-controlled Chinese yuan.

The yuan rose briefly to 7.330 to the dollar in early Beijing trade, its highest since it was unpegged from the dollar in July 2005, before retreating to 7.7360.

Analysts said the outcome of upcoming central bank meetings in Japan and the United States were not expected to erode the appeal of carry trades for now.

Both the Bank of Japan and the Fed are expected to keep interest rates unchanged when they announce decisions on Tuesday and Wednesday, respectively.

"The only risk is that we could have the Fed change their language to indicate a balanced approach to monetary policy. That's the biggest risk that's out there," said Busch.

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