The currency market remains caught in the crosscurrents of a growing wave of dollar selling — or speculation about it — and fears of central bank intervention.

The Bank of Japan intervened in the currency market for the first time in nearly six months last month. The BOJ stepped in when the greenback fell below 124 yen on May 23 and has since returned to the market repeatedly to keep the dollar from falling further.

Politicians and Finance Ministry officials appear obsessed with the bitter memory of 1999, when a strong yen fueled by foreign investors’ increased purchases of Japanese stocks put the brakes on the nation’s exports and stifled a nascent economic recovery.

Indeed, the recent developments on the domestic stock and currency markets were reminiscent of 1999, when market players were banking on an anticipated economic recovery in Japan.

The BOJ appeared to fear the dollar’s fall below 120 yen.

Basically, the yen as the currency of a surplus foreign trader tends to move higher, and a pickup in foreign demand for Japanese equities adds to the upward pressure on it. Enticed by signs of an economic pickup in Japan, foreign investors have increased the weighting of Japan in their equity holdings in recent weeks.

In China, now by far a trade surplus nation, its central bank is kept busy absorbing an excess supply of dollars.

The Chinese yuan is pegged to the dollar, and Chinese foreign trade transactions are settled with dollars.

As a result, the dollar is always in excess supply in China, keeping the yuan under upward pressure.

The actual supply and demand on the Chinese currency market is balanced, however, with China’s central and other banks serving as buyers of unwanted dollars.

If the Finance Ministry in Tokyo is to keep the yen from strengthening against the dollar at any cost, intervention at a time when the yen is not running in excess supply in capital transactions will cost the nation more than 10 trillion yen annually.

The market is now trying to test Japanese monetary authorities’ resolve.

Given the lingering fears of central bank intervention, the dollar-yen rate appears likely to remain caught in a 122 yen-125 yen range in the near term.

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