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The gap between Japanese and U.S. economic fundamentals has long been a major factor behind the dollar’s strong showing.

The dollar has given up much of its recent gains, however, and is now hovering around 128 yen.

Having hit a three-year high of around 135 yen late last January, the dollar appeared bound to the 130 yen level in recent months and now appears poised to test 125 yen.

The market is now locked in a cross current between pessimism over an early U.S. economic recovery and worries over a delay in Japanese structural reforms.

A slump in U.S. corporate fixed investment has offset many of the favorable effects of a pickup in consumer spending, clouding U.S. economic prospects.

There is speculation that Tokyo stocks’ unexpectedly strong showing in recent weeks has been fueled mainly by increased foreign buying.

Former U.S. Treasury Secretary Robert Rubin often reiterated his support for a strong dollar, and U.S. officials have often signaled to the marketplace that the U.S. foreign exchange policy remains unchanged.

Major factors behind the dollar’s recent strong showing include optimism over U.S. corporate earnings, federal tax receipts, and uptrends in U.S. bond and stock prices.

Having stayed at the 120 yen level for some time, the dollar generally hovered around the 130 yen level in recent months.

Skepticism abounds, however, over the outlook for U.S. financial markets.

Although the U.S. has been running a budget surplus for years, Washington has little choice but to continue to attract enough foreign capital to finance its bloated current-account deficit, now running at an annual rate of close to 4 percent of gross domestic product.

The Sept. 11 attacks and the subsequent U.S. military campaign in Afghanistan have raised worries about the lopsided conversion of international capital into the U.S. bond and stock markets.

Indeed, international investors have begun playing it safe and switching away from the U.S. markets.

If the euro strengthens to around $0.91, the dollar could drop below 125 yen.

Market participants will then begin guarding against intervention by Japanese monetary authorities.

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