The yen had its biggest one-day gain versus the dollar in almost nine years Thursday, as investors unwound risky trades financed with borrowed yen, on fears of a global funding crisis.
The yen soared against all major currencies and hit its strongest level since November against the euro, as the unwinding of carry trades accelerated on evidence companies across the globe were having increasing difficulty accessing credit.
In carry trades, investors finance purchases of more risky higher-yielding assets by borrowing in currencies with lower interest rates such as the yen.
In the United States, benchmark stock indexes sold off more than 1 percent as a report showing housing starts in July dropped more than expected. The data added to nervousness about the outlook for the U.S. economy as losses related to the U.S. subprime mortgage sector mounted.
"The strength of the yen has been driven by unwinding of positions that had been established over a very long period of time," said Meg Browne, senior currency strategist at Brown Brothers Harriman in New York.
"The market is also very concerned there will be a slowdown of the U.S. economy," Browne added. "There is concern that it will spread to the rest of the world."
The dollar was 1.8 percent lower against the yen at 114.31 yen , its lowest since July 2006. The euro slipped two percent to 153.24 yen , its lowest since March.
The selling in other cross-yen pairs exploded as options barriers were smashed and automatic sell orders triggered, with the Australian and New Zealand dollars on track for their steepest daily declines against the yen in about two decades.
"Attention is on the turbulence in international markets," said David Powell, senior currency strategist, at IDEAglobal in New York. "We're seeing the yen crosses rise as a result."
The Australian dollar fell as much as 5.6 percent against the yen in intraday trading, which would be its its biggest drop in 21 years, according to Reuters data. It last traded at 89.88 to the yen. And the New Zealand dollar slid 5.7 percent, its biggest decline in 20 years, to trade at 77.61 yen.
The Australian dollar has now lost more than 12 percent in the last six sessions, while the New Zealand dollar is down about 14 percent against the yen.
U.S. Housing Troubles
The sharp increase in risk aversion came after shares in Countrywide Financial, the largest U.S. mortgage lender, plunged on Wednesday amid rumors it was having trouble raising funding. Countrywide shares tumbled another 15 percent on Thursday after it said it had to draw all of an $11.5 billion credit line to fund operations after it was effectively shut out of other credit markets.
The euro was down against the dollar at $1.3407.
Earlier the dollar erased all its gains versus the euro after the U.S. Commerce Department said housing starts fell much more than expected in July.
"Some very weak numbers, which certainly show that the U.S. housing market remains weak," said David Watt, senior currency strategist with RBC Capital Markets in Toronto. "There has been such intense focus on the U.S. housing sector that any signs of weakness and its global implications, one of the factors spilling over into other markets, adds to the nervousness."
Reflecting the fears of the markets remaining rocky, the implied volatility on one-month dollar/yen options -- how much a currency pair is seen moving over a given period -- soared above 17 percent earlier to its highest in over seven years.
Japanese Prime Minister Shinzo Abe said on Thursday the nation's economy remains in good shape and he expects the Bank of Japan to make an appropriate decision on monetary policy while examining economic conditions.
The yen's surge is fueling trader speculation that Japanese intervention in the currency markets is a possibility. The last time Japan intervened was March 2004 as it wound up a period of yen-selling intervention totaling some $350 billion.