NEW YORK -- The yen surged Thursday, climbing to a three-month high against the dollar, as investors spooked by growing problems in credit markets fled risky assets financed by borrowing in the low-yielding Japanese currency.
Credit spreads widened, stocks fell sharply, and U.S. benchmark Treasury yields tumbled in a flight to quality that prompted currency traders to buy back yen that had been used to buy higher-yielding currencies like sterling in carry trades.
"It's clearly a case of the tail wagging the dog in the FX markets today," said Robert Sinche, global head of currency strategy at Bank of America in New York. "We're seeing a big rise in risk aversion and unwinding of positions in other markets, and that is hurting the carry trade."
Amid mounting fears that the U.S. housing market is deteriorating and worries that financing of corporate takeovers is becoming more difficult, the Dow Jones industrial average was on track for its biggest daily loss in five months.
Emerging market bond yield spreads over safe-haven U.S. Treasury bonds widened to a 13-month high, while U.S. and European junk bonds also took a beating.
Story Continues Below
The spillover to the currency market got even uglier after the dollar tumbled below its 200-day moving average against the yen, a long-term chart signal, triggering a wave of automatic orders to sell dollars and buy yen, dealers said.
By mid afternoon, the dollar was down 1.4 percent at 118.75 yen, on track for its biggest daily decline against the Japanese currency in around 5 months.
The euro slid 1.2 percent to 163.35 yen after plumbing a one-month low of 163.25 yen earlier in the session.
The yen's gains were most pronounced against the New Zealand dollar, which boasts the worlds highest interest rates and is a darling of Japanese investors, but was dealt a blow earlier in the day after the Reserve Bank of New Zealand said that it may have raised rates enough to cool inflation.
The kiwi fell 2.4 percent against the yen, the biggest decline since mid March, to 94.28 yen.
Meanwhile the euro rose 0.2 percent to $1.3752, around one cent below a record high hit earlier in the week.
Dealing another blow to the dollar, U.S. new home sales fell unexpectedly sharply in June and prices slumped, according to a government reports on Thursday that pointed to continuing weakness in the housing sector.
"It's bad news all around for the dollar," said David Powell, senior currency strategist with IDEAglobal in New York. "That doesn't bode well for the category of GDP that's been a drag for so long, residential fixed construction."
The government will release its first reading of gross domestic product in the second quarter on Friday, which is expected to show a solid rebound from the first quarter, when the economy grew at the slowest pace in more than four years.
© Reuters 2007. All rights reserved. Republication or redistribution of Reuters content, including by caching, framing or similar means, is expressly prohibited without the prior written consent of Reuters.
Editor's note:
Beat the Falling Dollar With These 4 Foreign Currency Plays.
The 3 Best Income Stocks in the World
Buffett: The best book ever written on investing.
