Dollar, yen gain as risk appetite diminishes

The dollar, which was on track for its biggest monthly gain versus the euro since the single currency’s launch in 1999, was also being boosted by month-end demand from global fund managers seeking to rebalance foreign exchange hedges in their portfolios.

Financial markets took little comfort in the Bank of Japan’s interest rate cut, the latest monetary policy initiative after central banks in the United States, China, and other countries lowered rates this week to stem the negative impact of the credit crisis on their respective economies.

European shares stumbled after Japan’s Nikkei stocks average shed 5 percent on Friday as investors were unconvinced a 20 basis point rate cut by the BOJ would do much to avoid a slowdown in the economy.

“Risk aversion has once again returned to the market and that’s why we’re seeing the dollar and yen benefit again,” said Matthew Strauss, senior currency strategist at RBC Capital Markets in Toronto.

“There is also a lot of profit-taking going on after sharp gains over the last few days in equities including high-yielding currencies,” he added.

In early New York trading, the euro was down 1.2 percent at $1.2751, while it fell 1.8 percent against the yen to 124.95 yen. The dollar was down 0.7 percent at 97.97 yen.

The dollar showed little reaction to data showing a slight easing in U.S. prices pressures and a decline in consumer spending, which dropped for the first time in two years. For the story, click on ID:nN30398097.

Investors were also disappointed by the BoJ’s less than expected rate cut as equities fell. Earlier, the speculation was that the Japanese central bank would cut interest rates by 25 basis points.

The yen, meanwhile, strengthened despite the rate cut, with investors focused on Friday’s blood bath in global equity prices. The Japanese currency was up 7.7 percent versus the dollar on the month so far, en route to clock its biggest gain in 10 years.

Traders on Friday will also be focused on the daily fixings in the currency market, which could reflect significant month-end buying of the U.S. dollar.

“It appears possible that substantial FX hedge adjustments have to be made by asset managers after a substantial declines in asset values throughout October,” said Goldman Sachs in a research note.

“This kind of flow should typically favour lower-yielding currencies relative to higher-yielding ones. However, given the mechanics are relatively clear, speculative accounts may have positioned for this already and therefore major crosses may display some volatile bounces throughout the day.”