Dollar calls in demand as investors bet on upside versus yen
* Dollar rises to 2-month high vs yen even as implied volatilities ease
* Diverging outlooks for U.S./Japan monetary policy favour dollar over yen
TOKYO, Nov 15 (Reuters) - A slide in the yen to a two-month low against the dollar on Friday is likely to have further to go, as the options market shows some investors betting on dollar strength in the weeks ahead.
One-month risk reversals, which gauge demand for whether investors prefer to bet on a rising or falling dollar against the yen, turned last week to favour dollar calls -- bets the currency will rise -- instead of puts earlier this month, for the first time since late May.
The dollar rose as high as 100.315 yen on Friday, even as implied volatilities on dollar/yen options eased to around 8.88 percent from a one-month high of 9.80 percent on Tuesday and Wednesday this week.
"Many people had thought it would be difficult for the dollar/yen to rise above 100. The year-end period is also generally speaking not a good time to volatility so many people had been selling volatilities," a currency options trader at a European bank said.
Some market participants bought dollar calls to cover short positions but as the market tends to be quiet during year-end, people are cautious about buying volatility too much, he added.
Still, the greenback could face resistance near its September high around 100.60 yen, and much depends on the direction of U.S. Treasuries, said Marc Chandler, global head of foreign exchange strategy at Brown Brothers Harriman. The 60-day correlation between U.S. Treasuries and the dollar-yen is near 0.62, Chandler said in a research note.
Going forward, diverging monetary policy outlooks in the United States and Japan generally favour a stronger dollar, as the yield differential between U.S. Treasury notes and Japanese government bonds could widen.
As of the U.S. close on Thursday, the 10-year yield differential was around 210 basis points. It rose as high as 216.5 basis points earlier this week, its widest since September - which was its widest since April 2011, according to Thomson Reuters Datastream data.
The U.S. Federal Reserve is on track to taper its monthly purchases of $85 billion in assets, with most investors expecting the central bank to begin paring by March 2014.
By contrast, the Bank of Japan is expected to maintain its ultra-easy stance -- and possibly ease further -- as it aims to achieve 2 percent inflation within two years.
"JGB yields remain mostly unchanged while U.S. yields resumed their uptrend, basically because of stronger-than-expected U.S. data," said Naomi Muguruma, a senior fixed-income strategist at Mitsubishi UFJ Morgan Stanley Securities.
On Thursday, Muguruma noted that U.S. yields came down after Janet Yellen, nominated to be the next Fed leader, raised expectations the central bank will maintain its economic stimulus.
But an improving U.S. economy lessens the need for stimulus. Recent data has surprised on the upside, including a greater-than-expected rise in October nonfarm payrolls.
"We think tapering will start in March next year, so we have to see how strong the U.S. data will be," said Muguruma, adding that she believes the 10-year U.S. Treasury yield will rise near 3.0 percent by March, from the U.S. close of 2.70 percent on Thursday.
JGB yields will "more or less trade sideways" for the rest of 2013, she said, with the 10-year JGB yield likely rising toward around 0.8 percent by the end of Japan's fiscal year in March, from 0.630 percent on Friday.