Federal Reserve measures to ease liquidity constraints would tend to weaken the yen, but underlying risk aversion is likely to remain at elevated levels over the next two weeks.

The yen gained sharply following the US Federal Reserve interest rate decision on Tuesday as the refusal to sanction a bigger cut in the discount rate triggered a sharp unwinding in carry trades as Wall Street came under strong selling pressure. The yen pushed to highs around 110.50 against the dollar with a jump stronger against the Euro as volatility increased.

The yen weakened back to beyond 111.00 on Wednesday as regional stock markets attempted to stabilise. Any Federal Reserve measures to ease strains in the US money markets by a new method of injecting liquidity to a wider spread of institutions would tend to be a net positive for the US currency against the yen with a reduced risk of carry-trade unwinding.

Volatility levels are, however, likely to remain high with liquidity fears persisting as markets move towards the year-end period with cash hoarding liable to increase and this will provide important yen support.