Nov. 12 (Bloomberg) -- The yen strengthened against 16 of the most-traded currencies, rising beyond 110 per dollar for the first time in 1 1/2 years, as investors reduced holdings of higher-yielding assets bought with loans in Japan.

The currency rose as much as 5 percent versus the Australian dollar and 2.3 percent against the euro as speculators retreated from carry trades. Investors cut holdings of riskier assets after Morgan Stanley analysts downgraded HSBC Holdings Plc because of mortgage defaults.

``You are seeing massive carry trade unwinding,'' said Michael Malpede, a senior currency analyst in Chicago at Man Global Research. ``The fear of contagion spreading from the U.S., coupled with rising volatility, are pushing investors away from risks.''

The yen rose 1.1 percent to 109.43 per dollar at 10:32 a.m. in New York, the highest since May 2006, from 110.69 on Nov. 9. It gained 2.1 percent to a two-month high against the euro of 159.01, from 162.48. Malpede said the yen may strengthen to 108 per dollar this month.

The dollar rose 1 percent against the euro to $1.4536, from $1.4678 last week. It fell to an all-time low of $1.4752 on Nov. 9.

Dollar-Yen Volatility

Volatility implied by dollar-yen options expiring in one month with a strike price near current levels rose to 16.8 percent from 15 percent on Nov. 9. Traders quote volatility, a measure of expectations for currency swings, as part of pricing options. Volatility was last higher on Aug. 16, the day before the Federal Reserve cut its discount rate to encourage banks to lend to each other.

Investors pared carry trades as concern grew about writedowns on securities tied to defaults on U.S. subprime mortgages. Shares of HSBC Holdings Plc, Europe's biggest bank by market value, fell to the lowest in almost three months after Morgan Stanley downgraded the stock on the view provisions for defaults will swell.

``The market has to realize this crisis isn't yet complete and that means a lot of these carry trades are at risk,'' said Hans-Guenter Redeker, head of currency strategy at BNP Paribas SA in London, and the most accurate foreign-exchange forecaster last quarter in a Bloomberg survey. ``We are running on fear this week. There is a lot of negative potential in the news.''

In carry trades, investors sell currencies of countries with lower borrowing costs and buy assets with higher interest rates. Japan has the lowest borrowing costs among industrialized nations at 0.5 percent.

Carry Trade

In a yen-funded carry trade, investors use Japanese loans to buy assets in places with higher rates such as New Zealand's, where the benchmark interest rate is 8.25 percent, or Australia, which has a 6.75 percent rate. Currency fluctuations can turn profits earned into losses.

The yen gained 3.8 percent to 81.46 versus the New Zealand dollar and 3.8 percent to 16.0934 versus the South African rand. The Swiss franc, a popular source of funding for the carry trades with benchmark borrowing costs of 2.75 percent, rose 3.5 percent versus the Australian dollar and 1.1 percent versus the Canadian dollar. The three biggest losers against the yen and the Swiss franc were the high yielders in South Africa, New Zealand and Australia.

The dollar's decline is so steep that Japan, the nation with the most debt and the lowest interest rates, is attracting global bond funds.

JPMorgan Asset Management, a unit of the third-largest U.S. bank, and Kokusai Asset Management Co., which runs the second- biggest managed debt fund, boosted holdings of Japan's bonds as the yen rose 11.8 percent against the U.S. currency since the end of June. MFC Global Investment Management (Japan) Ltd., a unit of Canada's largest insurer, predicts 10-year note yields will fall to the lowest since 2005.

Central Banks

Central banks from Bogota to Mumbai are imposing foreign- exchange curbs to take control of their soaring currencies from traders dumping the dollar.

In Colombia, international investors buying stocks and bonds must leave a 40 percent deposit at Banco de la Republica for six months. The Reserve Bank of India created a bureaucratic thicket to curb speculation by foreign money managers. The Bank of Korea is investigating trading of currency forward contracts to limit gains in the won.

Gains in the yen may be limited on speculation Japanese importers will take advantage of its gains by selling it for other currencies to buy goods overseas.

``We haven't seen the yen this strong in a while, so Japanese importers may want to sell into this rally,'' said Masahiro Sato, joint general manager of the treasury division at Mizuho Trust & Banking Co. in Tokyo, a unit of Japan's second- largest publicly traded lender.

Dollar Index

The dollar has fallen 9.3 percent against the currencies of six major trading partners this year, the ICE U.S. dollar index shows. The measure reached a record low of 74.978 on Nov. 9. The currency reached an all-time low versus the synthetic deutsche mark on Nov. 9 of $1.3260, a theoretic value of the currency that preceded the euro.

Data due this week may show U.S. retail sales growth slowed. Purchases rose 0.2 percent in October after increasing 0.6 percent in September, according to a Bloomberg News survey. The Commerce Department will release the report on Nov. 14.

``The dollar is likely to be sold further,'' said Kenta Inoue, currency analyst at Mitsubishi UFJ Securities in Tokyo, a unit of Japan's largest publicly traded lender. ``The economy is fragile and the Fed may have to lower rates again.''

The dollar may fall to $1.47 per euro this week, he said.

Central banks and finance ministries are setting up obstacles to keep the falling dollar from threatening company profits and economic growth.

The Bank of Korea is investigating trading of currency forward contracts to limit gains in the won. The Reserve Bank of India created a bureaucratic thicket to curb speculation by foreign money managers. The dollar last bought 911.17 won, from 906.75 on Nov 9. It traded at 39.3725 rupee, from 39.3256 on Nov. 8. India's financial markets were closed Nov. 9 for a public holiday.

To contact the reporters on this story: Bo Nielsen in New York at bnielsen4@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net

Last Updated: November 12, 2007 10:35 EST