Fear that Japan may soon intervene to weaken the yen after it hit a record high against the dollar left currency traders skittish on Thursday, and the market may start trimming yen longs as a G7 meeting nears.
The dollar hit a record low of 76.25 yen as Asian trading began after a break of 79.75 triggered a cascade of automatic sell orders. The dollar bounced back to 78.90 yen and has remained in a fairly tight range.
Everyone is on the lookout for intervention after yesterday's volatility, said Greg Anderson, strategist at Citigroup. Anybody who was long this week is out of the market, and the shorts are out too. People are in wait-and-see mode for the G7.
Finance officials of the Group of Seven countries will discuss steps to calm markets. A Dow Jones news report quoted an unnamed source as saying Japan's ministry was ready for battle on the yen.
C.J. Gavsie, director of FX sales at BMO Capital markets, said the market's jittery, liquidity is a concern and we think some sort of intervention from Japanese authorities is likely in some shape or form.
The dollar rebound was driven partly by Japanese importers and some retail margin traders. The latter were cited as a main factor behind the earlier plunge, with the speed of the decline -- the dollar shed more than three yen in about 20 minutes -- forcing them to dump trades financed with borrowed yen.
The yen has been strengthening since last week's earthquake hit Japan, with traders bracing for investors to start bringing money home to pay for reconstruction.
The yen also rose against the Korean and Chinese currencies. Analysts said that is especially worrisome for Tokyo because it undermines Japan's trade competitiveness relative to its Asian neighbors.
CHANCE OF SUCCESS HARD TO PREDICT
The G7 is set to meet around 6 p.m. (2200 GMT), and traders said the market may start trimming lingering yen longs shortly before that, which could push the dollar toward its session peak around 79.74 yen.
But absent intervention, there's little to stand in the way of further yen gains, said Alan Ruskin, Deutsche Bank's global head of G10 currency strategy.
The Japanese probably did themselves a bad turn when it comes to credibility by not stepping in sooner, Ruskin said.
People may be more inclined to fight intervention now than they would have been yesterday, and it looks like active types are looking to sell upticks, he added.
The cost of hedging against a further yen rise jumped, with implied volatility on one-month dollar/yen trading close to 20 percent, though still below levels seen at the peak of the 2008 global financial crisis.
Japan's finance minister, Yoshihiko Noda, blamed speculation for the yen spike and said he was closely watching markets, a warning that authorities may soon buy dollars.
Some analysts said intervention may be more effective this time than it was in September when Japan spent $26 billion to weaken the yen but failed to ensure a lasting dollar rally.
This entire move can be pinned down to speculative positioning rather than any repatriation flows, said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi. Since it is speculative, intervention in this case should work and clear out some of the long yen positions.
EURO, SWISS FRANC RISE
Elsewhere, the euro hit a 2011 high of $1.4052 after solid demand at a Spanish bond auction and on the view that euro zone interest rates were likely to rise soon. It was last up 0.9 percent at $1.4015.
The dollar also fell to a record low of 0.8852 Swiss francs before bouncing back above 0.90 francs. While the Swiss central bank kept interest rates steady, the franc got a bid from investors who see it as a safe port in a storm.
(Additional reporting by Julie Haviv in New York and Neal Armstrong in London; Editing by Kenneth Barry)