Euro Declines on Concern Nations Will Still Struggle After Loan Package

The euro fell for the first time in three days versus the dollar and yen on concern the region’s most-indebted nations will struggle to contain deficits even after policy makers provided an almost $1 trillion bailout.

The pound strengthened as Conservative leader David Cameron took over as Britain’s prime minister after Gordon Brown stepped down. The yen gained against all of its most-traded counterparts as concern a widening European fiscal crisis will damp appetite for riskier assets and push investors out of trades funded with the currency.

“From a currency perspective it’s troubling that these kinds of things are happening,” said Sebastien Galy, a currency strategist at BNP Paribas SA in New York. “You presumed when you were holding your nice, safe German bunds that you weren’t going to be stuck with some implicit claim on Greek bonds. And that’s what’s happening right now.”

The 16-nation currency dropped 0.8 percent to $1.2687 at 4:16 p.m. in New York, from $1.2787 yesterday, when it reached $1.3094, the highest level since May 4. The euro fell 1.4 percent to 117.65 yen, from 119.28 yesterday, when it rallied 2.1 percent. The dollar slid 0.6 percent to 92.73 yen.

The euro traded below $1.2755, its close on May 7 before euro zone leaders agreed to loans of as much as 750 billion euros ($952 billion), including support from the International Monetary Fund. Greece’s budget deficit of 13.6 percent of gross domestic product is the second highest in the euro area after Ireland’s 14.3 percent ratio.

The euro has lost 8 percent this year, according to Bloomberg Correlation-Weighted Indices. The dollar has gained 5.3 percent, and yen has advanced 5.7 percent.

Japan’s Yen Gains

The pound gained 0.7 percent against the dollar to $1.4952 and 1.5 percent against the euro after Brown’s resignation.

Cameron will form the first Conservative administration since 1997. Nick Clegg’s Liberal Democrats are weighing whether to join in a coalition or support a minority government. Brown had pledged to halve the U.K.’s record budget deficit by 2014, while the Conservatives said they would go further and faster.

Stocks fell, with the Standard & Poor’s 500 Index declining 0.3 percent and Europe’s Stoxx 600 Index fell 0.5 percent.     Japan’s currency gained against more than 150 currencies as yen-funded investments in higher-yielding countries such as Mexico and South Africa lost money, Bloomberg data show.

Endangered Carry Trade

Australia’s dollar fell 1.3 percent to 83.13 yen on speculation investors reversed carry trades that had profited from the nation’s 4.6 percent one-month deposit rates. Japan’s benchmark rate of 0.1 percent makes the yen a popular funding currency for such trades. Such strategies lose money as the funding currency gains because it costs more to repay the loan.

The Aussie-yen carry trade may be “endangered” as investors pare expectations for Reserve Bank of Australia rate increases, wrote Ashraf Laidi, chief market strategist at CMC Markets in London.

“The latest sell-off in global equities has begun to unwind one of the few remaining carry trades in the non-emerging market foreign exchange space,” Laidi wrote in a note to clients today. “The Aussie may no longer be favored by the automatic assumption of ‘buy on dips.’”

The Reserve Bank of Australia has raised interest rates too quickly to 4.5 percent and isn’t likely to increase borrowing costs further in coming months due to concerns of a second global slowdown, according to former central bank governor Bernie Fraser and Bob Gregory, previously an RBA board member.

Dollar Option Strategy

Credit Suisse Group AG said investors should wager the dollar will rise to 100 yen in six months via an option strategy known as a digital knockout because the Bank of Japan may have to extend monetary easing in the second half of the year. The Federal Reserve will probably start raising rates in the same period, the Zurich-based bank said.

“Interest-rate spreads will start to move against the yen,” said Aditya Bagaria, a currency strategist at Credit Suisse in London. “That would result in a weakening yen later in the year, not in the next two months.”

The option strategy bets that the dollar will remain below 98 yen for the next three months before rising to 100 yen by November. If successful, the strategy will pay an investor $915,000 after transaction costs of around $85,000 on a $1 million notional wager, Credit Suisse said.

The trade is designed so an investor’s maximum loss is the $85,000 fee to set up the bet, Bagaria said.

To contact the reporters on this story: Oliver Biggadike in New York at obiggadike@bloomberg.net; Ben Levisohn in New York at blevisohn@bloomberg.net

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