The yen firmed against the dollar and euro for a second day on Tuesday as worries about fallout in the US subprime mortgage sector prompted investors to unwind some trades funded by low rates in the Japanese currency.
Volatile stock markets, in part stemming from concerns about the exposure of US lenders to subprime mortgages in a declining housing market, has reduced investor interest in risky assets around the world.
"The risk appetite in the market is starting to wane a little bit given anecdotal evidence of what is going on in hedge funds and equities," said Joe Francomano, vice president for foreign exchange at Erste Bank in New York.
Mirroring Monday's moves, US stock indexes edged lower on Tuesday in volatile trading, weighed down by subprime concerns. The Dow Jones industrial average was down 0.1 percent at 13,337.66, while the Standard & Poor's 500 Index slipped 0.3 percent, at 1,492.89.
"We are into the summer months, we have a US holiday next week and we have got the quarter-end. This is a pretty good opportunity, to take some profits off the table especially in carry trades," Francomano added.
In carry trades, investors borrow in a low-yielding currency such as the yen or Swiss franc and invest in assets with higher returns. In late New York trading, the dollar was down 0.3 percent against the yen at 123.26. It fell as low as 122.81, its lowest level in about two weeks.
The euro slipped 0.3 percent against the yen to 165.89, well off a record high hit last week. Further helping the yen's cause was a warning from Japanese Finance Minister Koji Omi overnight about the weakness of the country's currency. He said at a news conference that it was important to be aware of the risks of making one-way currency bets, echoing warnings from Group of Seven officials. Foreign exchange officials from South Korea and New Zealand also said they were worried about the harm caused by the yen's weakness, compounding concerns about carry trades.
Still, analysts expect the sell-off in the dollar, at least against the yen, to be limited ahead of Wednesday's and Thursday's meeting of the Federal Reserve's policy-setting committee. Signs of a rebound in US growth have led many investors to expect the Fed to keep rates at 5.25 percent, for now, and not cut them.
"I think we're seeing limited risk aversion. The Fed is starting to sound hawkish and as a result dollar weakness could remain limited ahead of that," said Kathy Lien, chief FX analyst at DailyFX.com in New York.
Against the dollar, the euro was little changed on the day at $1.3461. The dollar was also flat against the Swiss franc at 1.2278 Swiss francs. Comments by Japan's Omi followed similar warnings from the Bank for International Settlements in its annual report on Sunday that there was "clearly something anomalous" about the yen's recent weakness.
In other markets, investors also liquidated positions in commodities, trying to stay liquid amid US subprime fears and a possible global economic slowdown. Benchmark metal copper on the London Metal Exchange, for years the darling of fund managers looking for a high-return asset, ended the day down $120 at $7,360 per tonne; gold hit its lowest level in three and a half months, and US crude futures dropped nearly 2 percent.