The yen tumbled and high-yielding currencies posted sharp gains as carry trades regained popularity Wednesday after Federal Reserve and other major central banks announced coordinated measures to ease the money market's liquidity crunch.
Investors viewed the move as a sign that central banks were being more responsive to the plight of global financial companies hurt by the credit crisis. This encouraged investors to get back into carry trades that involve selling the low-yielding yen in order to buy currencies with high yields.
Under the global central banks' plan, the Fed will auction short-term funds to depository institutions against a wide variety of collateral that can be used to secure discount window loans.
The move comes a day after the Fed disappointed markets Tuesday with 25-basis-point cuts in both the benchmark federal funds rate and the discount rate for lending to banks, to 4.25 and 4.75 percent respectively.
"This (central banks' move) is clearly good news for high-yielding currencies and carry trades," said Dustin Reid, senior currency strategist, at ABN Amro in Chicago.
"In essence, this takes away any concern over the lack of a 50-basis-point cut in the discount rate yesterday or less-than-dovish tendencies contained in the Fed's statement. The Australian and New Zealand dollars and sterling have the most to benefit from here, as do local market currencies such as the Brazilian real and Mexican peso," he added.
The year-end period typically sees thinner liquidity, but the situation is compounded this year by problems in the U.S. subprime mortgage market and the subsequent credit crunch, which have left banks reluctant to lend to each other.
The yen fell broadly, with the dollar rising to a one-month high at 112.46, up 1.6 percent. It last traded at 112.18, up 1.5 percent on the day. The euro also climbed to a one-month peak at 165.09 yen after the news, before trading back down to 164.86 yen, still a 1.7 percent gain.
The Australian dollar jumped nearly 3 percent against the yen to 99.33, while sterling gained about 2.1 percent to 229.67 yen.
In the money market, three-month dollar deposit rates fell to around 4.79 percent from 5.1 percent while euro and sterling money market rates also dropped.
The dollar, however, slipped against the euro, with the single currency trading up 0.2 percent at $1.4680, while sterling rose 0.6 percent against the dollar to $2.0462.
Analysts said the central banks' action could support the dollar against the euro and the pound in the near term as fears about the prospects of a U.S. recession have eased.
Bear Stearns analysts, however, said they can't help but feel that these measures were a "spur-of-the-moment" panic response by the Fed after Tuesday's moderate discount rate cut sparked steep losses in U.S. equities.
"If this is more of a panic move by the Fed and others than a long-thought out plan, we'd be a bit wary of seeing this as some sort of green light for selling the yen and buying into 'riskier' currencies," said Bear Stearns.