Reply #5: Yen rally takes wind out of dollar's sails

[EuroObserver]

NEW YORK, Feb 7 (Reuters) - The yen surged across the board on Tuesday amid market jitters before the Bank of Japan's policy meeting this week and a report that a large Japanese investor may shy away from dollars.

Currency traders cited these factors as reasons to cover large short positions in the low-yielding yen, which arrested the dollar's recent rise and pulled the greenback off from recent one-month highs against the euro and Swiss franc and seven-week peaks against the yen.

The sharp moves in the yen were mirrored in similar unwinding of positions in other asset classes, particularly commodities. Gold tumbled as much as $20 on the day, posting its biggest one-day fall <GCJ6> in nominal terms for over 12 years, while oil <CLc1> fell about 2.6 percent to below $64 a barrel.

"People who were short yen are a little bit nervous ahead of the BOJ policy meeting," said Brian Rose, currency strategist at The Bank of Tokyo-Mitsubishi UFJ in New York. "There's some speculation that (bank) Governor (Toshihiko) Fukui might signal that they're going to start cutting their liquidity target," Rose said.

As part of its fight against deflation, the BOJ floods the market with excess liquidity. The BOJ has said the possibility that it will end that policy could grow during fiscal 2006-07, which starts in April. However, the bank is expected to leave its policy unchanged on Thursday. A beginning of liquidity withdrawal would be seen as the first step toward the BOJ eventually raising interest rates from near zero, analysts say. But even a BOJ move in April, if it materializes, is still a few months away.

"Short-term positions have been squared up a bit ... but now is not the time for a sustained yen rally," said Robert Sinche, head of global currency strategy at Bank of America in New York, noting the broad and likely related bout of profit taking by speculators Tuesday in currencies, metals and oil.
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Also adding fuel to the yen-buying fire was a Bloomberg News report that Nippon Life, Japan's largest life insurer, said it sold U.S. Treasury bonds when the dollar was worth around 120 yen, and that it may buy more euro-denominated paper to reduce its exposure to the dollar. This sparked rumors that Nippon Life may not turn up at this week's $48 billion U.S. quarterly refunding auctions, some dealers said.

"The story is interesting in that it suggests the investment outflow from Japan to the U.S. is not totally insensitive to spot levels," wrote JP Morgan currency analysts in a note on Tuesday. "Concern that Japanese capital expatriation may weaken above 120 (dollar/yen) could be one possible explanation for the sharp bout of profit-taking in dollar/yen today."

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