The yen rose against the dollar for the first time in a week on Tuesday, rebounding from a 3 1/2-year low, as short and long-term investors opted to book profits on recent large bets made against the Japanese currency.
The yen's strength, however, should prove to be transitory given expectations that the Bank of Japan will embark on more aggressive monetary stimulus to boost its economy sooner than previously anticipated.
Bank of Japan policymakers are becoming more open to adopting the unorthodox policy options of the man expected to be the next BOJ governor, meeting minutes show, suggesting the central bank can push through bolder stimulus promptly.
The ideas included cutting the 0.1 percent floor the BOJ sets on money market rates, targeting longer-dated government bonds and boosting purchases of risk assets, the minutes show.
"The dollar should continue to appreciate against the yen, and the minutes overnight showed the BOJ is having a very lively debate about stimulus, with lots of options on the table," said Ben Emons, senior vice president/global portfolio manager, at Newport Beach, Calif.-based PIMCO, which had $2 trillion in assets as of Dec. 31.
"As an investor, I believe they will choose to buy more Japanese government bonds that have longer maturities," he said.
Buying bonds is tantamount to printing money and therefore would dilute the value of the yen.
Speculation of swift BOJ action was also triggered by a report in the Nikkei business daily that the government's nominee for Bank of Japan governor, Haruhiko Kuroda, hinted he may launch new monetary easing steps soon after he takes office next week, rather than wait for his first policy meeting on April 3-4.
Emons, who oversees $70 billion in global assets and also oversees PIMCO's Forex ETF fund, said dollar/yen should reach 100 to 105 over the next three months.
"But, it could drop as low as 92 if the BOJ disappoints by not being as aggressive as the market is expecting," he said.
The dollar last traded at 96.06 yen, down 0.2 percent on the day after earlier rising to 96.71 yen,its highest since August 2009, in Asian trade.
Expectations of forceful action from the BOJ have caused the dollar to gain smartly against the yen since late 2012. The greenback is about 10.7 percent higher so far this year, by far one of the strongest performances in the foreign exchange market.
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In the options market, near-term risk reversals, which measure relative demand for put and call options, flipped toward yen calls, or bets the yen will rise further, from puts, or bets it would weaken. This gave the yen some support, traders said, and cited profit-taking on long dollar positions.
"It looks like that the option market is not at all convinced that we will imminently see a second leg of yen weakness," said Olivier Korber, FX derivatives strategist at Societe Generale in Paris.
Nevertheless, dollar/yen has 100 in its sights.
The dollar index, which measures the greenback against a basket of other currencies, was nearly unchanged at 82.57. It hit a seven-month high of 82.924 on Friday after the release of data that showed above-forecast U.S. jobs growth.
The jobs data lifted yields on U.S. Treasuries, which tend to have strong positive correlation with dollar/yen as higher yields are thought to attract more bond investments.
Brighter US Outlook
Any pullback in the dollar could present a fresh buying opportunity to investors looking to add positions in favor of the greenback given an improving U.S. outlook just as other developed economies, including Britain, the euro zone and Japan are either struggling with recession or deflation.
The euro fell 0.1 percent to $1.3035, holding above Friday's three-month low of $1.2955. Traders reported option expiries at $1.3000 which would keep the currency tied around those levels.
"The market has not fully taken the idea of a European Central Bank rate cut off the table," PIMCO's Emons said.
"There is still a big difference in interest rates and lending rates, and with the ECB last week revising its inflation forecast downward, that gives it room to start working on a rate cut, which I expect to happen by the second quarter or third quarter," he said.
The euro is vulnerable to more selling, with the austerity-hit euro zone's economy expected to face an uphill battle to recover from recession.
"The euro should remain contained to a range of $1.30 to $1.40 over the next three to six months, but it should mostly stay on the weaker side at $1.30 or slightly below," Emons said.
Against the yen, the euro traded 0.3 percent lower on the day at 125.18 yen, below a 34-month high of 127.69 reached last month, according to Reuters data.