* Yen rises as euro, commodity currencies go into reverse
* Chrysler, banks, weak S&P futures keep investors wary
* Japan trade surplus falls on year but beats forecasts
By Charlotte Cooper
TOKYO, April 22 (Reuters) - The yen rose across the board on Wednesday as a rebound in the euro and commodity currencies faded, with the market on watch for clues about the health of the banking system as a key to longer-term direction.
The currency market is highly volatile at the moment, reversing steep moves from one day to the next, and the euro gained on Tuesday as an improvement in German investor confidence lifted stock markets and helped commodity currencies higher.
But that move ran out of steam and the market was reluctant to push the euro, the dollar or the commodity currencies higher against the yen in the wait for clarity on the health of the U.S. banking sector and on the future of automaker Chrysler.
Instead traders reported selling of euros for yen by model-driven funds on Wednesday as choppy, short-term trading dominated.
"The market looks at a stage of deciding whether to go long in yen again or not, after being pretty much done with cutting yen-shorts," a trader at a Japanese bank said.
The yen had been a favourite to sell against commodity currencies such as the Australian dollar as equity markets rose in recent weeks and optimism picked up that the global downturn was bottoming out.
Those short yen positions have been cut since early April due to uncertainty over factors such as the next step in European Central Bank policy and stress tests for U.S. banks, but the market is unsure how far to chase the yen up from here.
The euro edged down 0.1 percent to $1.2940, holding above this week's one-month low at $1.2888, and shed 0.5 percent to 127.23 yen after jumping nearly 1 percent on Tuesday.
The dollar shed 0.4 percent to 98.32 yen after gaining 0.8 percent on Tuesday. It hit a six-month high of 101.45 on April 6 but has gradually fallen since then.
"Yesterday's rally was just a correction from the sharp decline in equity markets and the dollar/yen and yen crosses. The general feeling is that the market is not dominated by optimism -- the markets are beginning to react to negative news," said Masafumi Yamamoto, head of FX strategy Japan at Royal Bank of Scotland.
"Any (dollar/yen) rally should be a good chance to sell, and Japanese exporters keep that in mind."
WHERE NEXT
The ECB is expected to cut interest rates to 1.0 percent from 1.25 percent in May but it is unclear whether it will follow the Federal Reserve and other central banks and create money via other means such as buying corporate or sovereign debt.
ECB Governing Council member Axel Weber told the Financial Times in an interview that the central bank had marginal room for more rate cuts and the euro zone had very limited scope for buying government debt in secondary markets.
The market is awaiting the outcome of the U.S. authorities' stress tests on banks. U.S. officials are expected to release details of the underlying assumptions of the tests on Friday, but actual results are not expected until May 4.
Treasury Secretary Timothy Geithner said most U.S. banks had enough capital to keep lending, but a pile of bad debts was fostering doubts about their health and slowing a recovery.
However, an International Monetary Fund report warned that global write-downs by banks and other financial institutions could reach $4.1 trillion as institutions seek to clean up their balance sheets..
Traders said continued uncertainty about the fate of troubled automaker Chrysler, which faces a deadline at the end of the month to complete restructuring talks, also made investors cautious of returning to riskier trades.
In Japan, data showed exports almost halved in March from a year earlier but analysts said there were signs the sharp slide in shipments was easing.
The trade surplus stood at 11.0 billion yen ($111.5 million) in March, down 99 percent from a year earlier but better than economists' forecasts for a deficit of 5.0 billion yen.
"The yen-positive sentiment spread as a result of the data," said Toru Umemoto, chief FX strategist Japan at Barclays Capital.
The Australian dollar fell 1.1 percent to 69.27 yen and 0.7 percent to $0.7044 after gaining 2 percent against the dollar on Tuesday.
Australian consumer prices rose 0.1 percent in the first quarter although average core prices remained stubbornly high, suggesting limited scope for interest rate cuts. ($1=98.63 Yen) (Editing by Michael Watson)