LONDON: The dollar clawed back some lost ground against the yen on Wednesday after a sharp selloff the previous day, though its gains could run out of steam if another bout of weakness hits stock markets.
Some doubts on whether the Federal Reserve will pare back its ultra-loose monetary policy later this year weighed on the dollar in early European trade, but traders said investors were buying it at lower levels given the US economy was in better shape than the euro zone and Japan.
The dollar index was up 0.2 percent at 81.268, off a 3-0.5 month low of 81.034 struck on Tuesday. The dollar was up 0.7 percent against the yen at 96.70 yen, having lost nearly 3 percent on Tuesday, while it recovered from 3-0.5 month lows against the euro.
"We are seeing a shakeout of the long dollar-short yen trade, given that the BOJ has refrained from taking additional measures," said Mankesh Jain, head of FX and Investment Management at hedge fund Solo Capital.
"But we expect the BOJ to address the issue and look to buy dollar/yen at 96 yen, with stops at 95 yen for an eventual move to 99 yen."
Yen shorts were squeezed after the Bank of Japan disappointed investors hoping for an extension in the maximum duration of its fixed-rate loans to try and quell volatility in the bond market.
Global stock markets and emerging market assets were also sold off on Tuesday, hit by expectations that the Federal Reserve may start to taper its bond buying plan later this year.
That drove investors to the safety of the most liquid currencies like the yen and the dollar. Of the two, the yen is preferred during times of market turmoil.
LONG DOLLARS
Since the start of this year, speculators and long-term investors have been building favourable dollar positions on the back of good first-quarter US economic data. Some are now trimming those bets and booking profits.
"Q2 US economic data is softer and this appears to be limiting investors' desire to lengthen dollar positions despite the greenback's safe-haven status," Jane Foley, senior strategist at Rabobank wrote in a note.
Given that confidence in the euro zone was better than a year ago, investors were hesitant to build large bets against the common currency.
The euro hit a 3-0.5 month high against the dollar in early European trade, rising to as high as $1.3335, before giving up those gains to trade at $1.3276, down 0.3 percent. As such, the euro, remained vulnerable to losses if borrowing costs for some of the most indebted euro zone countries rose.
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