The yen rose broadly Thursday after brokerages downgraded two of the largest U.S. banks, knocking equities lower and sparking fears that fallout from the credit crisis may sap investor appetite for risk.
Two of the hardest hit currencies were the Australian dollar and the New Zealand dollar, which have the highest interest rates among developed economies and have been popular targets of carry trades.
In those strategies, investors borrow in low-yielding currencies like the yen and then sell them to buy higher-yielding ones in order to profit on the difference.
Unwinding those trades benefits the yen.
"Carry trades are being unwound, with the sell-off in global equities weighing on risk appetite," said Omer Esiner, senior market analyst at Ruesch International in Washington.
The U.S. dollar, though down against the yen, rose against the euro for the first time in six sessions as markets pared back expectations the Federal Reserve will cut interest rates in December, analysts said.
On Wednesday, the Fed trimmed its benchmark interest rate by a quarter percentage point to 4.5 percent and said that the chances of higher inflation are now roughly equal to the risk of slower growth.
By The Numbers
In early afternoon trade, the dollar fell 0.4 percent against the yen to 114.86, after earlier falling as low as 114.50 yen.
The euro was down 0.6 percent at 165.95 yen.
Against the dollar, the euro dropped 0.2 percent to $1.4450, a day after it hit a record peak above $1.45, according to Reuters data.
The Australian dollar fell 1.6 percent versus the greenback to US$0.9170. On Wednesday, it surged to a 23-year peak above US$0.9340. The Australian dollar was on track for its biggest one-day decline against the U.S. dollar since August.
Waiting for Payrolls
Trading in the U.S. dollar was quiet ahead of the October U.S. employment report on Friday, which could heavily influence views on what the Fed may do at a policy meeting in December.
Dealers in the interest rate futures market have priced in a 60 percent chance of a Fed easing next month, from about 38 percent earlier in the day, but analysts said the increase was mainly due to steep losses in U.S. equities.
In tandem with falls in higher-yielding currencies, U.S. stocks posted sharp losses Thursday after a downgrade of Citigroup by a brokerage.
Gold also pulled back from a 28-year high, retreating just before the key $800 level after a fall in oil prices.
Thursday's U.S. economic reports showing modest inflationary pressures in September and a cooling of manufacturing activity last month had just a fleeting impact on the dollar. Overall, recent U.S. data, outside of the housing sector, reflected an economy that was more resilient than many initially thought, making Friday's payrolls report more intriguing.
"The data over the last few days showed the economy is not as bad as the market had thought, and we don't have any evidence of a recession yet," said Boris Schlossberg, senior currency strategist at DailyFX.com.
"So that means there's quite a good chance the Fed will remain stationary for the rest of the year," he added.