The yen gave back some of its gains on Wednesday following a huge jump on Tuesday sparked by a rout in global equity markets.
The yen leapt 2 per cent against the dollar on Tuesday – its biggest one-day gain in more than a year.
Some analysts said the yen benefited as a rise in risk aversion saw investors unwind carry trades, in which long positions in high-yielding currencies are funded by selling low-yielding currencies such as the yen and Swiss franc.
However, analysts were divided as to whether the trend would continue.
“We do not believe the current unwinding of carry trades is sustainable and expect dollar/yen and euro/yen to resume their rallies once the technical correction in the equity markets has run its course, “ said Matthew Strauss, senior currency strategist at RBC Capital Markets.
But Simon Derrick, chief currency strategist at Bank of New York, said the conditions were ripe for a more sustained yen rally.
He said that it was reasonable to estimate that the overall scale of the yen carry trade going into Tuesday was at close to record levels, given that a significant number of yen funded investments were likely to have been put back on in the latter part of last week following the Bank of Japan’s decision to raise interest rates.
“It therefore also seems reasonable to suppose that there are still a substantial number of positions to be unwound despite the events of the past 24 hours,” said Mr Derrick.
However, David Bloom, currency strategist at HSBC, said Tuesday’s sharp drop in dollar/yen was not down to a carry-trade unwind but was the result of a realisation that the US slowdown was not over, but had in fact received a new lease of life.
Mr Bloom said the market had been comfortable with the status quo over the last couple of months, ignoring the deterioration of US economic fundamentals while it was too busy selling yen.
“That meant when the realisation hit home about the US economy, we saw a sudden and dramatic change in market sentiment,” he said.
“Given the weight of positions, the biggest reaction came in dollar/yen, giving the impression that this is all about a carry unwind.”
The yen fell 0.5 per cent to Y118.50 against the dollar, having hit a 10-week high of Y117.51 on Tuesday, and fell 0.2 per cent to Y156.50 against the euro by mid-afternoon in New York.
Meanwhile, the Swiss franc, which also rallied sharply on Tuesday, eased 0.3 per cent to SFr1.2215 against the dollar.
The dollar also rose 0.2 per cent to $1.3210 against the euro, showing little reaction to a large downward revision to US fourth-quarter GDP and new homes sales data that came in far weaker than expected.
Ian Gunner, currencies strategist at Mellon Financial, said given the rise in volatility, any currency having previously enjoyed excess positioning would be at risk.
He said euro/dollar should be included under this heading given that data last week showed that net long speculative euro/dollar positions hit a record high on the Chicago Mercantile Exchange. “If there is a big flow out of emerging markets, this tend to offer support for the dollar via flows back into the dollar investor base,” Mr Gunner added.
Sterling eased 0.1 per cent to $1.9595 against the dollar but rose 0.2 per cent to £0.6738 against the euro after mixed economic data.
Figures from the Nationwide building society showed UK house price inflation rose at an annual rate of 10.2 per cent in February, however UK consumer confidence fell unexpectedly.
Howard Archer, economist at Global Insight, said the softness in consumer confidence, following news that UK retail sales fell sharply in January, reinforced doubts about consumer spending’s ability to sustain the robust level seen in the fourth quarter of 2006.
“We suspect that relatively moderate consumer spending over the coming months will increasingly constrain the ability of retailers to push through significant price hikes and help to limit the peak in interest rates to 5.5 per cent,” he said.