WHY is the yen so strong? This is the most common question I am asked by anyone who follows the currency markets. It is easy to understand the perplexity. Japan has been mired in deflation and low growth for more than twenty years.

Yet the price action in dollar-yen has nothing to do with the country’s woeful economic fundamentals. These days, the yen’s strength is simply a reflection of the dollar’s weakness. The Fed’s intention to engage in a second round of quantitative easing (QE), buying billions of dollars of government debt, has sent the greenback tumbling against all of its major trading partners, including the yen. One result is that US bond yields have hit record lows. Dollar-yen has followed suit, declining as the spread between 10-year Japanese government bonds and 10-year Treasuries has narrowed. Even the Bank of Japan’s (BoJ) announcement of its own quantitative easing program has not stopped dollar-yen drifting lower.

Part of the reason is that Japanese policymakers have been extremely cautious, allocating only $50bn for their QE initiative – a pittance relative to the Fed’s anticipated $500bn-$1 trillion. Furthermore, with the G-20 meeting just ahead, most traders are convinced that the BoJ will not intervene again. The shorts are therefore primed to break through stops at the key ¥80.00 figure.

But they may be overconfident. I believe that if the pair does approach the ¥80.00 level, Japanese officials may not stand on ceremony and will once again intervene because the pain to their export sector will be greater than any diplomatic damage that they suffer as a result. Furthermore, if US economic data shows any sign of improvement, the Fed could curtail the size and the scope of its QE, which could prove very bullish for dollar-yen. So unless US data deteriorates markedly, dollar-yen may hold at ¥80 and the pair could rebound from there.

Boris Schlossberg and Kathy Lien are directors of currency research at GFT. Read commentary at or e-mail