[NYTr] Yanqui Dollar Displaces Yen, Swiss Franc as Favorite for Currency Speculation

[All the News That Doesn't Fit]

Bloomberg - Nov 26, 2007 (posted 11/25/2007)
http://www.bloomberg.com/apps/news?pid=20601103&sid=aWMXWN6PFHa4

Dollar displaces yen, Swiss franc as favorite for carry-trade funding

By Bo Nielsen

NEW YORK -- Using the dollar to pay for purchases of currencies
with higher yields is proving to be the most profitable trade in
the foreign-exchange market.

A basket of currencies including the British pound, Brazilian real,
and Hungarian forint financed with dollars returned 17 percent this
year, compared with 9 percent when funded in yen and 7 percent in
Swiss francs, according to data compiled by Bloomberg. Falling U.S.
interest rates and increasing volatility in the yen and franc are
making the trade even more appealing.

"With the dollar giving the appearance of being in free fall, it
increases the attractiveness of using the currency to fund investments,"
said Avinash Persaud, chairman of London-based Intelligence Capital
Ltd., which advises hedge funds that manage more than $89 billion.
"That process will only add more fuel to the decline."

The last time the U.S. currency was used for so-called carry trades
was in 2004, when the Federal Reserve's target rate for overnight
loans between banks was 1 percent, said Niels From, a strategist
at Dresdner Kleinwort in Frankfurt. Since then, it has weakened 18
percent on a trade-weighted basis, according to a Fed index. The
International Monetary Fund says the dollar made up 64.8 percent
of central banks' currency reserves in the second quarter, down
from 71 percent in 1999.

Investors are borrowing dollars and using the money to buy assets
in countries with higher interest rates even though U.S. borrowing
costs are 4 percentage points more than the Bank of Japan's and
1.75 percentage points above the Swiss National Bank benchmark. In
carry trades, speculators get funds in a country with low borrowing
costs and invest in one with higher returns, earning the spread
between the two.

Housing Slump

Speculation against the dollar increased as the worst housing slump
since 1991 forced policy makers to cut the benchmark rate twice to
keep the economy out of recession. The currency depreciated in five
of the past six years leading central bankers from the Arabian
Peninsula to China to diversify their reserves and increase holdings
of non-U.S. assets.

The dollar dropped 1.2 percent last week against the euro to $1.4837,
and has weakened 12 percent so far in 2007. The U.S. currency has
depreciated 10 percent versus the yen this year, including 2.5
percent last week to 108.35 yen. It fell to a record 1.089 Swiss
francs on Nov. 23.

Investors may switch more than $100 billion of borrowing from yen
or francs into dollars in the next two years for carry trades said
Jens Nordvig, a strategist with New York-based Goldman Sachs Group
Inc., the biggest U.S. securities firm by market value.

Real, Won, Pesos

The value of futures contracts held this month by hedge funds and
traders betting against the dollar was a record $33.9 billion more
than contracts that profit from a gain, according to New York-based
Morgan Stanley, the second-biggest U.S. securities firm.

Pacific Investment Management Co., which oversees the world's biggest
managed bond fund, is selling dollars against the Brazil real,
Mexican peso, Korean won, and Singapore dollar.

"When we think about currencies on a three-to-five-year basis we're
very bullish on emerging markets versus the U.S. dollar," said
Andrew Balls, who helps manage $80 billion for Newport, California-based
Pimco. "That view is only reinforced when you look at interest-rate
differentials."

The real rose 18.5 percent this year and Singapore's currency
strengthened 6.4 percent, while the won was little changed. The
Mexican peso fell 1.4 percent, the only one of the 16 most-traded
currencies to do worse in the foreign exchange market.

Interest Rates

Pimco, a unit of Munich-based insurer Allianz SE, expects the Fed
to lower borrowing costs to around 3 percent, from 4.5 percent.
Policy makers have reduced the rate by 0.75 percentage point since
Sept. 18.

Interest-rate futures on the Chicago Board of Trade show investors
see a 58 percent probability that the U.S. benchmark will drop to
3.75 percent by March 31. Switzerland's key rate is 2.75 percent
and Japan's is 0.5 percent.

The dollar produced a positive carry, the combined gain from the
difference between interest rates and changes in foreign exchange,
against 20 of the 24 most actively traded emerging market currencies
this year, Bloomberg data show. The franc was positive against 12
and the yen versus 14.

Using a currency to finance bets can drive down its value. Former
Japanese vice finance minister Hiroshi Watanabe said in May that
one reason the yen had fallen to a record low against the euro was
because it was funding about $500 billion of carry trades.

Attracting Speculators

The dollar attracted speculators when the Fed cut the target rate
from 6.5 percent in 2001 to 1 percent in June 2003 and kept it there
for a year, said Dresdner Kleinwort's From. When the Fed started
to raise borrowing costs, traders fled. The U.S. rate surpassed the
European Central Bank's benchmark in December 2004, helping the
dollar gain almost 13 percent versus the euro the following year.

Strategists say the U.S. currency will recover because the economy
is adding jobs and producing faster inflation, limiting the Fed
from reducing borrowing costs. The dollar will rebound to $1.42 per
euro and to 113 yen by the end of June, according to the median
forecast of 41 analysts surveyed by Bloomberg.

The Fed will probably cut its target a quarter-point to 4.25 percent
in the next three months and leave it there through 2008, according
to a separate survey from Nov. 1 to Nov. 8. The U.S. economy will
accelerate to a 2 percent annual growth rate next quarter, from the
current 1.5 percent, the survey showed.

"We're actually bullish the U.S. dollar," said Jack McIntyre, who
helps manage $25 billion at Brandywine Global Investment Management
LLC in Philadelphia. "As long as the world doesn't fall off a cliff,
we will see people continue to play the carry trades and the yen
will be the premier funding currency."

'Safer Source'

The dollar is becoming more attractive for speculators concerned
that higher volatility will reduce profits from bets funded in yen.
An increase in price swings dents returns by raising the risk that
gains from the spread between interest rates will be erased by
foreign-exchange losses.

The yen appreciated 8.7 percent against the dollar since Oct. 15
as implied volatility on one-month dollar-yen options climbed to
14.97 percent from 7.47 percent. Dealers quote implied volatility,
a gauge of expectations for currency moves.

"The dollar becomes a safer source of funding" as volatility rises,
said Maxime Tessier, head of foreign exchange in Montreal at Caisse
de Depot et Placement, which manages $151 billion.