The dollar held near a 10-month peak against the yen on Monday after upbeat US data last week on retail sales and consumer sentiment further squashed expectations for the Federal Reserve to cut interest rates early next year.
Market players said the US currency's run higher against the yen may finally push it over the 120 yen line this week, but that with short yen positions reaching massive levels the Japanese currency may stage a near-term rebound.
"I don't think the dollar has over-extended itself, but there is room for concern, particularly against the yen," said Joseph Kraft, head of forex and interest rates at Morgan Stanley in Tokyo.
"Just from a psychological point of view, we need to hit that 120 mark before there's a correction," he said. Investors will keep an eye out, as Fed officials will be out in force speaking on Monday, including Chairman Ben Bernanke, St. Louis Fed President William Poole and San Francisco Fed President Janet Yellen.
Poole gave some of the most cautious remarks yet from the Fed in an interview with Reuters last week, saying that the risks were bigger for weaker growth than an inflation flare-up.
The dollar was at 119.65 yen little changed from the level in late New York trade on Friday when the US currency rose as high as 119.88 yen on electronic trading platform EBS, the strongest since mid-December.
The euro was also nearly flat on the day at $1.2510 after having hit $1.2484 on Friday, the weakest since July. The next major technical support level for the euro is $1.2456, the July low.
The dollar was at 1.2740 Swiss francs, coming off a six-month high of 1.2771 francs hit on Friday. Traders said the Swiss currency took a cue from the euro's rebound against the dollar on buying at dips.
The euro was little changed at 149.65 yen. The minutes of the Fed's last meeting in September and recent comments from most policy-makers have indicated that they see a bigger risk of inflation staying higher or picking up than the housing market shakeout hitting the overall economy.
The yen failed to hold gains made on Friday after Bank of Japan Governor Toshihiko Fukui would not rule out the possibility of another rate increase this year, though he repeated the central bank would likely raise rates only gradually.
Most market players believe the BOJ will wait until the first quarter of 2007 before lifting rates to 0.5 percent from the current 0.25 percent, partly to see how US growth holds up.
The BoJ's go-slow approach to normalising rates from zero has prompted waves of investors and speculators to sell the Japanese currency and use the funds to buy higher-yielding foreign currencies and bonds.
"Net yen short positions have been building over the past several months, and this is more to do with investors eyeing interest differentials rather than speculative plays on currencies," said Takao Hattori, senior investment strategist at Mitsubishi UFJ Securities.
The latest data from the International Monetary Market showed that net yen short positions jumped to a record 123,598 in the week ending October 10 from 104,151 the previous week. Such a big amount of outstanding yen short positions suggests that speculators are prone to reversing them in a hurry if the Japanese currency were to stage a rebound near-term.
But speculators are not the only ones dumping the low-yielding yen. Japanese household investors also remain sizeable sellers of their own currency to buy foreign bonds.
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