The Yen soars as investors shun risk but the dollar up vs. Euro

Forex outlook:

The yen soared on Thursday as investors ditched risky trades funded by low rates in the Japanese currency after one of Europe's biggest banks froze funds with links to the troubled U.S. subprime market. The euro, meanwhile, fell as much as 2 percent against the yen and 1 percent against the dollar after France's largest bank, BNP Paribas temporarily suspended redemptions at three funds worth 1.6 billion euros, sending overnight U.S. and euro zone borrowing rates soaring.

The high-yielding Australian and New Zealand dollars dropped nearly 2 percent against the yen, as investors scrambled to unwind carry trades. "Not surprisingly, the yen is the strongest G10 currency followed by the Swiss franc as carry trades come under pressure," said Stephen Malyon, senior currency strategist at Scotia Capital in Toronto. In carry trades, investors borrow in a low-yielding currency such as the yen and invest in higher-yielding assets. "The source of this volatility is far more damaging than the Shanghai equity bubble in early February/late March that caused a flare-up in the markets. The risk going forward is that there would be more skeletons that may fall out of the credit closet," he added.

Reflecting a big rush into cash, European overnight borrowing rates spiked to their highest level since October 2001, prompting the European Central Bank to inject a record amount of around 95 billion euros into the system in a quick overnight tender.
U.S. overnight rates spiked around a half-percentage point to 5.86 percent, the highest since early 2001. Meanwhile, the big slide in high-yielding currencies marked a stark contrast to the previous day, when investors waded back into carry trades a day after the Federal Reserve's statement that acknowledged downside risks but said U.S economic growth would remain solid. "Clearly the revelation of sub prime concerns in Europe caused a total reverse of yesterday when we thought calm was entering the market," said John McCarthy, director of foreign- exchange trading at ING Capital Markets. In the United States, sub prime troubles have haunted the investment bank giant Goldman Sachs Group Inc.

As the fallout from the sub prime mortgage crisis spread, U.S. short-term rate futures traded sharply higher on Thursday, suggesting that traders are now pricing in roughly a 60 percent chance that the Fed will cut rates by September. The market is fully pricing in a quarter-percentage-point Fed rate cut by October. By that point, the European Central Bank is expected to have raised rates another quarter point to 4.25 percent at its September meeting.

Gold: Gold fell more than two percent on Thursday to a one-week low as concern over liquidity flared in credit markets and central bank gold sales dampened sentiment. "A lot of investment funds are in trouble nowadays and if this continues, they would reduce a lot of risk positions, including gold, in their effort to generate some dollars," said Michael Kempinski, senior precious metals trader at Commerzbank. "Physical demand is not strong anymore. There is a risk of downside movement in gold," he added. Traders also said that heavy gold sales by some European investment banks pushed prices to intraday lows. Stocks and credit markets weakened while the yen and safe-haven bonds surged after BNP Paribas suspended three funds hit by problems in the risky U.S. mortgage sector, triggering a new wave of risk aversion. The French bank said it has suspended the funds as problems in U.S. sub prime mortgages and diminishing liquidity are preventing it from calculating their value. The news renewed worries those troubles in U.S. mortgages would spread globally by hitting banks, with the reprising of risks threatening to trigger a credit crunch and weigh on corporate and economic activity. "People are selling gold to raise dollars. It's a classic risk-aversion trade," said John Reade, head of metals strategy at UBS Investment Bank.

Crude Oil: U.S. crude oil futures ended sharply lower on Thursday as stock markets fell further on worries over losses in the sub prime mortgage sector. Crude’s losses were pared by stronger heating oil, which was helped by a lower-than-expected rise in supplies of natural gas, a competing product. "Crude fell on Wall Street's drop over the sub prime mortgage market troubles, but was later on supported by strong heating oil and natural gas," said Tom Knight, trader at Truman Arnold in Texarkana, Texas. Support at $71.00 was breached in electronic trade as traders and analysts watched an area, first at $71.38 and then the territory between $71.27 and $71.05 get taken out. Crude futures have fallen more than $8 or 10 percent from the record $78.77 intraday peak on Aug. 1. The Energy Information Administration said at midmorning that U.S. natural gas stocks rose last week by 42 billion cubic feet, much less than the 52 BCF predicted in a Reuters poll of analysts. But while natural gas futures padded gains on the latest data, analysts cautioned that support may be short-lived as storage was still much above the five-year average. 

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