The yen firmed broadly on Friday as continued turbulence in global financial markets caused investors to shun risk, cutting their exposure to carry trades.
High-yielding currencies like the Australian and New Zealand dollars weakened sharply as steep declines in global equities further soured investors' risk appetite -- already hit by fears of a liquidity and financing squeeze.
Short term U.S. dollar deposit rates on Friday surged above 6 percent -- well above the Federal Reserve's 5.25 percent Fed funds target rate -- as banks scrambled for cash amid deepening concern about credit market losses, which pummeled equities and spurred a rush to unwind risky carry trades.
Worries deepened on Thursday after France's biggest listed bank, BNP Paribas, froze 1.6 billion euros ($2.19 billion) worth of funds, citing trouble with the U.S. subprime mortgage sector.
The subsequent jump in euro zone overnight borrowing rates forced the European Central Bank to inject nearly 100 billion euros of funds into the banking system.
It acted again on Friday, injecting 61.05 billion euros into the euro zone money markets, for a net drain of 33.791 billion euros in cash.
Other central banks, including the Fed, have acted in a similar manner, although to a much lesser degree.
People are closely watching money markets because that's where we're seeing the signs of stress -- but things have improved slightly, euro zone money market rates have come back down to more normal levels, BTM UFJ currency economist Derek Halpenny said.
I wouldn't be any means say that we're out of the woods yet, there are still some pronounced risks -- if there was a deeper liquidation of positions the yen could strengthen further, he added.
At 6:30 a.m. EDT the dollar was down 0.2 percent from late U.S. trade at 117.94 yen, heading back towards the four-month low of 117.16 yen hit according to Reuters earlier this week.
The Aussie fell 0.6 percent to 99.66 yen, while the kiwi dropped 1 percent to 87.83 yen, having earlier struck a three-month low of 87.30 yen.
The euro was down 0.2 percent at 161.19 yen, and was flat against the dollar at $1.3671.
Yen volatilities hit multi-year highs -- one-month implied dollar/yen vols flirted with 11 pct earlier, their highest in a year, while one-week vols hit 13.6 percent, their highest in over 3 years.
MONEY MARKETS EYED
The ECB's record-setting liquidity injection on Thursday was followed by similar but much smaller operations by the Fed, Bank of Canada, Bank of Japan and the Reserve Bank of Australia.
Analysts said these operations, the ECB's aside, didn't amount to emergency action.
There's need for some kind of concerted leadership/clarity from central banks to try and re-instill confidence back into the financial markets, BTM UFJ's Halpenny said.
The broader fear is that financial market volatility eventually filters through to the macroeconomic environment.
While the bad news from the U.S. subprime and related markets continues this volatility is likely to go on, Standard Chartered analysts wrote in a note to clients on Friday.
Rates futures markets slashed bets on how high the ECB will lift rates. September Euribors are now pricing only a 50-50 probability of rates rising next month, compared with around a 70 percent likelihood on Thursday.
Fed funds futures are now fully discounting a U.S. rate cut by the end of the year, although the surge in ultra-short term dollar deposit rates is lending the dollar some support, analysts said.
The tumult in global financial markets has also stirred doubts about whether the Bank of Japan will raise interest rates later this month.