The yen fell broadly on Thursday as easing global credit concerns prompted a surge in buying of higher-yielding currencies and assets funded by borrowing at low rates in the Japanese currency.
A growing sense of calm and confidence returning to troubled financial markets this week was also reflected in gains across global equity markets and falling government bond prices and interest rate futures.
The recovery in financial markets was mostly fueled by lingering expectations the Federal Reserve will cut the benchmark interest rate, analysts said. In fact, U.S. rate futures have priced in two fed-funds rate cuts of 25 basis points each this year.
"Everything is rosy at the moment with risk aversion declining and investors happy to put money in risky assets and carry trades," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.
"There's also possibly a bit of short-covering after sharp yen gains. But all this is predicated on the view that the Fed is going to cut rates this year," he added.
Carry Trade Rebounds
In early New York trading, the dollar was up about 1.0% on the day against the yen. The greenback was on pace to post its biggest one-day gain versus the yen since early April. The euro was also up against the yen.
Earlier, the Bank of Japan left interest rates unchanged at 0.5%, easily the lowest in the industrialized world, although Governor Toshihiko Fukui warned that the bank could not keep low rates forever. His comments suggested that the BoJ may resume its tightening campaign by October.
Still, that failed to deter market appetite for carry trades, in which investors borrow in a low-yielding currency to invest in assets with higher returns.
Meanwhile, the European Central Bank on Thursday injected 40 billion euros of funds via a three-month money market operation, furthering restoring confidence in the market.
The move followed news overnight that Bank of America would invest $2 billion in Countrywide Financial, the largest U.S. mortgage lender.
Traders also seemed to have taken comfort from the meeting earlier in the week between U.S. Treasury Secretary Henry Paulson and Federal Reserve Chairman Ben Bernanke, as well as the Fed's decision last week to lower its discount rate.
"It all seems to have contributed to stabilizing concerns in the markets and that has added to appetite for selling the yen," said Derek Halpenny, senior currency economist at BTM-UFJ.
The higher-yielding New Zealand and Australian dollars were sharply higher against the yen. The Kiwi and the Aussie were also up against the U.S. dollar.
Sterling jumped back above $2.00 for the first time in over a week to $2.0056, while the euro rose against the greenback as well.
Analysts warned that carry trades aren't without risks. If anything, the conditions that perpetuate carry trades may be deteriorating.
Currency market volatility has fallen from last week's abnormally high levels but is unlikely to return to the ultra-low levels of recent years. Also, the fallout from the recent financial market turmoil will likely have a negative impact on economic growth in coming quarters, potentially leading to lower U.S. rates to avert a slowdown.