* Yen holds near one-week highs vs USD & euro
* Markets nervous as Middle East tension heats up
* U.S. & allies gear up for probable military strike against Syria
By Ian Chua
SYDNEY, Aug 28 (Reuters) - The safe-haven yen held at one-week highs against the dollar and euro early in Asia on Wednesday, having posted its biggest rally in over two months as investors scrambled for safety amid heightened geopolitical tensions.
The United States and its allies were gearing up for a probable military strike against Syria that could happen within days as punishment for last week’s chemical weapons attacks blamed on President Bashar al-Assad’s government.
The dollar fell to 97.10 yen, from a high around 98.54 on Monday. A break below the Aug. 20 low of 96.91 could pave the way for a retest of this month’s trough under 96.00.
The shift to safety seemed to benefit Treasuries, with 10-year yields down at 2.72 percent for a sizable 21 basis point drop in just three sessions.
The euro traded at 130.00 yen, well off Monday’s peak around 131.72, while the Australian dollar wallowed at 87.18 following a 2-percent drop.
Against the greenback, the euro edged up to $1.3394, helping knock the dollar index to a one-week low.
Emerging markets currencies were hit hard initially, although most managed to regain their footing. The Mexican peso plumbed a two-month low of 13.373 per dollar at one stage before recovering to 13.240.
“To me it is actually not clear that Syria is necessarily that big a negative for global markets for more than a few days,” CitiFX’s Head of Latam Strategy Dirk Willer said in a note.
“But the outsized reaction in EM suggests that EM is still extremely fragile and can easily get buffeted by any negative headline.”
Indeed, many emerging markets were already on shaky grounds thanks to an outflow of hot money as investors positioned for the U.S. Federal Reserve to begin scaling down its bond-buying stimulus next month.
“Assuming that the more drastic scenarios do not materialize, we expect the FX impact from Syria to be temporary,” BNP Paribas currency strategists wrote in a note.
“A more important dynamic is the process of asset reallocation from emerging markets which is likely to persist.”
Market sensitivity to U.S. data will also likely be restored in the months ahead as more liquid trading conditions return following the end of the summer lull, they added.
U.S. data on Tuesday showed home prices rose in June, while consumer confidence rebounded in August.
There is little in the way of market-moving news in Asia. Bank of Japan Deputy Governor Kikuo Iwata is scheduled to speak at the Kyoto Chamber of Commerce and Industry later.