Yen slumps past 111 per dollar as U.S. Treasury yields soar

© Reuters. FILE PHOTO: Euro, Hong Kong dollar, U.S. dollar, Japanese yen, pound and Chinese 100 yuan banknotes are seen in this picture illustration, January 21, 2016. REUTERS/Jason Lee/Illustration

By Kevin Buckland

TOKYO (Reuters) - The yen slumped to an almost three-month low to the dollar and a two-week trough versus the euro on Tuesday, as rising bond yields in the U.S. and Europe lured Japanese investors.

The yen lost about 0.2% to 111.21 per dollar, a level not seen since July 2.

It weakened about the same amount to 130.07 to the single currency after earlier touching 130.115 for the first time since Sept. 14.

The yen also weakened ahead of a ruling party election on Wednesday that will decide Japan's new prime minister, with frontrunners Taro Kono and Fumio Kishida both backing more stimulus to support the pandemic recovery.

While benchmark 10-year Japanese government bond yields remain pinned near zero by the Bank of Japan's yield curve control policy, equivalent U.S. Treasury yields have soared to a three-month high, touching 1.516% overnight.

German 10-year bund yields, while below those on JGBs, have catapulted to the highest since the start of July at minus 0.191% from as low as minus 0.340% just a week ago.

"The main impact of higher Treasury yields on currencies has been to see USD/JPY make further upward progress," Ray Attrill, head of FX strategy at National Australia Bank (OTC:NABZY) in Sydney, wrote in a note to clients.

"111 will be a tough (nut) to crack, bearing in mind the pair has spent only two days with time above this level so far this year - and with 10-year Treasury yield having been as high as 1.77%."

U.S. yields have been pulled up by a hawkish shift at the Federal Reserve, which announced last week it may start tapering stimulus as soon as November and flagged interest rate increases may follow sooner than expected.

That was reinforced by hawkish tones from the Bank of England and Norges Bank, which last week became the first developed-nation central bank to raise interest rates, dragging other global bond yields higher.

But despite an initial pop in the dollar index - which measures the currency against six major rivals - to as high as 93.526 for the first time in more than a month, it has since moved mostly sideways, and was last not far off from Monday at 93.385.

Against the euro, the dollar was little changed at $1.16995, hovering near the more than one-month high of $1.16835 reached on Thursday.

Still, many analysts expect the dollar to rise over time.

"As much as taper in and of itself is not a surprise, an earlier end to its program will reinforce that downside risks to the U.S. dollar have diminished," Mazen Issa, senior FX strategist at TD Securities, wrote in a research note.

"If the last taper cycle was any indication, about half of the U.S. dollar's cyclical upswing was observed three months after taper," he added.

TD expects the Fed to end its quantitative easing program by June 2022.

Fed officials, including one influential board member, on Monday tied reduction in the Fed's monthly bond purchases to continued job growth, with a September employment report now a potential trigger for the central bank's bond tapering.

Fed Chair Jerome Powell, who will join Treasury Secretary Janet Yellen, speaks before Congress on Tuesday.

The European Central Bank also begins a two-day conference later in the day, with Governor Christine Lagarde giving opening remarks.

Elsewhere, the risk-sensitive Australian dollar gained 0.25% to $0.73065, adding to Monday's 0.4% rally after data showed retail sales fell less than expected last month during the COVID-19 lockdown.

Receding concerns about contagion from China Evergrande Group's debt woes has been provided support, along with a recovery in the price of iron ore, although the commodity slipped back Tuesday for the first time in four days.

"We still see steel production curbs and worries about Chinese property developers as having some way to run," Westpac strategists wrote in a report.

"With the Fed set to begin taper in the months ahead, fresh lows below $0.7200 await."