The low-yielding yen jumped against the dollar and euro on Thursday as investors trimmed exposure to carry trades after BNP Paribas said three of its funds were hit by problems in the U.S. subprime mortgage sector.
The French bank decided to suspend temporarily redemptions from the funds which prompted a sharp pullback in foreign exchange carry trades, a fall in equities and a rally in government bonds.
Investors had tentatively dipped their toes back into carry trades -- borrowing yen to fund purchases of high-return assets -- on Wednesday, encouraged by calmer financial markets after the U.S. Federal reserve cooled expectations for a rate cut.
The Fed also acknowledged market turbulence caused by credit market jitters but maintained economic growth would continue.
However, worries about the impact on the wider economy from problems in the U.S. subprime market, extending credit to borrowers with poor credit histories, refused to subside. The yen rallied and high-yielding units like the Australian and New Zealand dollars weakened.
Subprime reared its ugly head in France this morning and who knows where it will pop up tomorrow, RBC senior currency strategist Adam Cole said.
There is nothing else driving markets at all other than risk aversion or risk appetite driven by how concerned the market is about subprime, he added.
By 3:56 a.m. EDT the dollar was down almost 0.5 percent on the day at 119.09 yen, while the euro slid 0.6 percent to 164.10 yen, having hit a low of 163.73 yen earlier.
The euro/yen pair also weighed on euro/dollar as the single currency slipped 0.1 percent to $1.3779, although July's record high of $1.3852, according to Reuters data, was still within reach.
HIGH-YIELD RALLY CRUMBLES
The high yielding Aussie and New Zealand dollars, popular targets for carry trades, also felt the strain of risk aversion falling 0.3 percent and 0.7 percent on the day, respectively, versus the U.S. dollar.
Both currencies had been supported in Asian overnight trade as solid employment data in both countries reinforced the outlook for policy rates to stay high at 6.5 percent and 8.25 percent respectively, luring yield-hungry investors.
Asian stock markets tracked a third day of solid gains on Wall Street, with Japan's Nikkei share average climbing over 1 percent.
However the ripple of risk aversion stopped European stocks from tracking Asian gains, with the FTSEurofirst 300 index down 0.6 percent at 1,544.84.
The mini-credit crunch problem needs time to be digested. This is a correction, but it's not over yet. Equity markets will remain bumpy, said Kikuko Takeda, a currency strategist at Bank of Tokyo-Mitsubishi UFJ.
Fears about the fallout from rising U.S. subprime mortgage defaults and spreading losses in credit markets have spooked investors in the past few weeks.
Several major U.S. companies have announced losses from exposure to these subprime loans, sending jitters across the financial services sector.