The yen was feeling pressure on Tuesday on speculation that the Bank of Japan might loosen policy while bigger risk appetites following last week's Federal Reserve easing last week helped keep the dollar near a seven-month low against a basket of currencies.
That left the euro close to four-month highs both against the yen and the dollar, though some traders think the single currency's rally since late July may run out of steam soon. The dollar traded at 78.69 yen, after having risen as high as 78.93 yen on Monday, way above a seven-month low of 77.13 yen hit just last Thursday, driven by buying by speculative accounts such as hedge funds, traders said.
"There's quite a lot of expectations about the BoJ's easing priced in now. The dollar/yen is unlikely to fall much ahead of the outcome of the BoJ's policy meeting," said a senior trader at a European bank, referring to the bank's two-day meeting that started on Tuesday.
The Federal Reserve's announcement last week of a new asset-buying programme has spurred speculation that the BoJ might also look into policy easing to prevent the yen from strengthening. "We expect the Bank of Japan to increase its asset buying fund by five trillion yen ($63 billion). If it does, the dollar might have a chance to break resistance around 79.50 yen. Alternatively, if it doesn't, the dollar will fall below 78 yen," said Osamu Takashima, chief Japan FX strategist at Citibank.
The dollar/yen has traditionally had a high correlation with US bond yields, partly based on the perception that higher US yields should attract more dollar-buying by Japanese investors. "The Fed's QE3 had been considered as the possible biggest reason to push the dollar against the yen. But now with US bond yields rising on expectations the QE3 will boost the economy, buying in the yen has lost momentum," said Yunosuke Ikeda, senior FX analyst at Nomura Securities.
The yen also might be undermined slightly by concerns about anti-Japan protests in China, Japan's biggest trading partner, over a territorial dispute. For now, the dollar/yen is capped at the bottom of the cloud at 78.72 on the daily Ichimoku chart, though a break there could open the way for a test of the August 20 high of 79.66 yen, some market participants said.
The euro stood at 103.02 yen, having rallied to a four-month high of 103.858 yen on Monday. Against the dollar, the euro fetched $1.3095, down slightly from late US levels but still not far from a high of $1.3173 hit on Monday. The euro has rallied about nine percent from a two-year low of $1.2042 in July when investors were deeply worried that the currency bloc might be heading for a break-up as Spanish and Italian borrowing costs were soaring.
For now, the euro is supported by optimism that the European Central Bank's new bond buying programme could help Madrid survive its debt crisis, though some are concerned that Spanish bond yields have risen over the past few days. The dollar index, which hit a seven-month low of 78.601 on Friday, rose to 79.02. The Australian dollar traded at $1.0452, well off a six-month high of $1.0625 set on Friday, pressured by worries that slower growth in China would put the brakes on Australia's mining boom.
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