* Yen underpinned as stock markets volatile
* Dollar index rebounds from four-month low
* Investors look to Fed next week for policy clarity
By Anirban Nag
LONDON, June 14 (Reuters) - The yen extended gains against the dollar on Friday, putting it on course for its best weekly performance since early 2010, as volatile stock markets drove investors to the safety of the Japanese currency.
However, the dollar was up against a basket of currencies, as investors sought safety in liquidity as uncertainty lingered over how long central banks will maintain stimulus measures.
Nikkei futures fell and European stocks lost earlier momentum, pushing the yen higher. The dollar was down 0.5 percent at 94.90 yen while the euro fell nearly 1 percent to 126.35.
Dollar/yen has moved in step with the Nikkei in recent weeks as investors unravel the sell-yen, buy-stocks trade that dominated between November and May. The fall in stocks has prompted investors to pare the dollar hedges put in place to protect them from a weakening yen.
“The correlation with Nikkei futures will continue for some time, until the Japanese authorities take steps to address volatility,” said Jeremy Stretch, head of currency strategy at CIBC World Markets.
“Also the unwinding of long dollar/short yen trade has been excessive as the U.S. data is expected to print better. Any drop in dollar/yen towards 93.60 is an opportunity to go cautiously long on the dollar.”
The dollar has lost close to 10 percent since May 22, when it peaked at 103.74 yen. The drop has seen implied volatility jump, while three-month risk reversals, a gauge of relative demand for put or call options, were flipping towards yen calls, or bets the currency will gain.
Commerzbank head of FX research Ulrich Leuchtmann said the dollar was unlikely to make much headway against the yen, until there was more clarity about central banks’ monetary policies.
“The risk-off (sentiment) we see is mainly due to markets being unsure about the monetary policy of the future ... this is good reason to be cautious of risky assets and to look into safe havens like the yen,” Leuchtmann said.
The current bout of market turbulence started when investors began worrying that the Federal Reserve will start scaling back its stimulus programme this year.
The Fed next meets on June 18-19, and investors expect more clarity from chairman Ben Bernanke. Some expect him to assure investors the Fed will keep policy accommodative and that it is in no hurry to tighten policy, just yet.
“For the coming week, markets should position for Bernanke trying to assuage market fears,” said Alan Ruskin, strategist at Deutsche Bank.
The dollar index was up 0.15 percent at 80.85, recovering from a four-month low of 80.500 on Thursday. Its gains saw the euro slip to $1.3321, off its four-month high of $1.3390 on Thursday.