Tokyo, August 22 - The yen held gains against the dollar and euro on Wednesday as investors shed risky positions after sluggish Tokyo stock prices served as a reminder that confidence in the credit market has yet to be restored.
The soft tone in the Japanese equities market subdued investors' appetite for risk, keeping conditions ripe for an ongoing unwinding of yen carry trades, in which the low-yielding currency is used to buy assets in higher-yielding ones.
The Dow Jones industrial average ended in negative territory on Tuesday even as the S&P 500 and the Nasdaq rose after Federal Reserve Chairman Ben Bernanke suggested that the central bank was prepared to lower its federal funds rate if necessary.
Analysts said investors are wary of taking on risk as conditions in the commercial paper markets, a critical source of short-term funding, remain tight given ongoing turmoil in the U.S. subprime mortgage sector.
"There remain some credit fears in the U.S. and in Europe," said Tomoko Fujii, senior economist and strategist at Bank of America in Tokyo.
"But the dollar/yen's downside should be limited as long as expectations continue for an appropriate policy response by the Fed," she said, referring to a cut in the fed funds rate.
The dollar was little changed at 114.40 yen recovering from a fall to 113.99 yen on electronic trading platform EBS in early trade as investors took profits on the yen's latest gains.
The yen was supported by a 0.1 percent slip in the Nikkei stocks average, although other Asian stocks rose.
Analysts said that dollar support was building around 114.00 yen, which may limit a fall in the U.S. currency after it hit a 14-month low of 111.60 yen last week.
The euro edged up to $1.3480 The single currency rose 0.1 percent to 154.10 yen after sliding as low as 153.36 yen early on Wednesday.
FUNDS RATE CUT?
As markets regain their composure after last week's panic selling, analysts said that investors will slowly begin to warm to carry trades, although problems in credit markets were likely to keep a lid on such demand in the near term.
Data from the Tokyo Financial Exchange showed net long positions in all seven cross/yen pairs rose by 12,367 contracts to 197,381 on Tuesday, indicating that Japanese margin traders are tip-toeing back into high-yield currencies.
During a meeting on Tuesday, Bernanke told Sen. Christopher Dodd, chairman of the Senate Banking Committee, that the Fed would use "all available tools" to calm financial markets.
That initially raised expectations that the Fed may soon lower its funds rate after trimming its discount lending rate late last week.
Richmond Federal Reserve Bank President Jeffrey Lacker poured some cold water on chances of an imminent interest rate cut, saying market turmoil only warrants a change in rates if it affects the outlook for inflation or growth.
The Bank of Japan begins a two-day policy meeting on Wednesday and is expected to hold rates at 0.5 percent given recent volatility in financial markets. Market participants had originally expected the central bank to lift rates to 0.75 percent this month. (Additional reporting by Rika Otsuka)