The Yen Won't Fall Much More Now. By Nicholas Hastings

Yen bears have a little further to run on the downside--but not much.

The factors that have been driving the dollar higher against the yen all this month will soon turn against the U.S. currency, as the rise in U.S. yields encourages Japanese investors to lock in rates of return that are at least double what they can get at home.

As currency strategists at BNP Paribas SA put it: "Despite the prospects of a further dollar/yen rebound in the coming week...we expect the medium-term relationship between dollar/yen and the yield curve to remain intact."

The yen has been under pressure for most of this month, with the dollar climbing steadily from a low of about Y88 to around Y92 as global appetite for risk has fallen back.

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Even though global equity markets have risen as third-quarter earnings have proved even better than expected, rising concern over the global economic recovery has dominated sentiment. Many of the better earnings figures are being seen as unsustainable in the longer term once cost-cutting is over.

Not only have expectations for the global economy been scaled back, but sentiment on Japan has been hit particularly hard.

While the Bank of Japan has expressed some optimism over the economic recovery, the Ministry of Finance has its doubts and has been calling on the central bank not to exit any stimulus policies prematurely.

The dollar has been benefiting, meanwhile, not only because it is now seen as more of a safe haven than the yen, but also because U.S. yields have been on the rise, making the dollar that much more attractive than its Japanese counterpart.

Although the Federal Reserve has continued to suggest that U.S. interest rates will remain low for an "extended period," there is a rising perception in the marketplace that this won't last for long.

Increasingly, market players are looking for the Fed to start hinting that there is a risk of rate increases in the first half of next year.

This speculation has only been fed by the actual increase in U.S. Treasury yields: 10-year bonds now offer more than 3.50%. This compares with under 1.5% for the Japanese equivalent.

But it is precisely this shift in yield differentials that will sow the seeds for the dollar's reversal against the yen.

As Japanese investors' appetite for U.S. assets grows, they will take advantage of the steeper yield curve to hedge their Treasury exposure.

The team at BNP Paribas again outlined the move: "Their investment intentions for the second half of the fiscal year appear to be centred around reducing unhedged foreign bond and currency exposure further, suggesting that the yen will remain supported over the medium term," the analysts said.

So although near-term pressure may yet push the dollar up as far as Y94, the U.S. currency is likely to find support ebbing away. A fall back towards Y88 looks more likely as 2009 comes to an end.

The dollar was having a little bit of a setback against the yen early Wednesday in Europe after a general decline in market appetite for risk pushed the Japanese currency higher against most other majors.

The dollar was being supported elsewhere by strong demand for the $44 billion 2-year Treasury note auction on Tuesday but an unexpected fall in U.S. consumer confidence, and resulting decline in global stocks, took their toll on sentiment.

By 0805 GMT, the dollar had fallen to Y91.20 from Y91.82 late on Tuesday in New York, according to EBS. The euro was up at $1.4817 from $1.4802 but it fell to Y135.15 from Y135.88.