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Wasn’t it just a few weeks ago that USD/JPY had broken above 100.00 and looked as if it was going to surge all the way up to 120.00?

After all, the Bank of Japan revamped its monetary policy program when Governor Kuroda took over and basically doubled its monthly bond purchases.

Seeing how serious the BOJ was about weakening the yen stimulating the economy, everyone and his grandma thought that the 2013 trend would continue.

But as we all know, things aren’t that simple in the forex market! Before you could order a bottle of sake, the yen came roaring back the past couple of weeks! What the heck is going on!

Hmmm… It’s time to dig deep and see what are the possible factors behind the yen rally.

Japanese Equities Take a Hit

Japanese stocks have gone on a massive slide over the past couple of weeks, as it seems that risk aversion is creeping into the markets. Just last May 22, the Nikkei 225 was sitting at 15,942.20.

Next thing you know, the Nikkei dropped a whopping 7.3% the following day. At the time, some felt that it may just be a technical correction, considering that the index had rallied 50% in 2013.

However, ten trading days later, the Nikkei 225 is now trading below the 13,000 level, marking an incredible 18% drop from the high!

It appears that the combination of poor data from China and concern about rising bond yields got investors skittish, causing them to unload their positions in riskier assets.

Remember, many investors use the yen as funding currency for their positions in higher-yielding assets. Once it’s time to unload though, it means that they have to reverse their short yen positions and start buying up the yen.

Traders Unwind Ahead of Jobs Report

Another reason why the yen rallied so hard was due to a massive dollar sell-off during the middle of the week. With the ADP report failing to hit expectations, word on the street was that the non-farm payrolls report on Friday would follow suit.

This led to a massive dollar sell-off, including one on USD/JPY. With traders scaling down their positions and looking to park their assets in safe haven currencies, the yen became one of the markets beneficiaries.

Stop Hunts

With the way USD/JPY was trending up the charts, I’m sure there were tons of people looking to buy the pair, especially on short retracements. After all, USD/JPY hadn’t made any steep retracements earlier in the year. Why would things be any different?

However, one by one, USD/JPY sellers broke through 101.00, 100.00, 99.00, until it finally busted its way down to 95.00 earlier this week. I suspect that many traders put their stop losses just below these key levels. Once USD/JPY broke lower to hit new lows, the selling became even more exaggerated, as all those stops got triggered.

Lack of Faith in the Japanese Government

The biggest reason though why the yen killed it this week was because of how the markets reacted to the comments made by Japanese officials.

First, the markets were unimpressed with Shinzo Abe’s speech earlier this week, who said that Japan could overcome deflation if the country continues to stick with aggressive monetary policy.

Unfortunately, the markets didn’t buy into his vision, and this triggered selling in Japanese equities and buying of the yen.

Second, when asked about the strongest yen rally since 2010, Finance Minister Taro Aso came out and said that the BOJ had no plans to stem the tide! He basically said go ahead and keep buying the yen!

Naturally, the markets saw this as a sign that the government isn’t as adamant about weakening the yen as it previously had been.

What now?

The truth is the yen is in a state of flux right now, and it’s pretty trick to see where this is headed.

On one hand, you could look at this as a VERY steep retracement and the time to buy in on long yen pairs could be just around the corner.

On the other hand, overall risk aversion and Aso’s recent comments may make you wanna think twice about shorting the yen. Could it be that the BOJ has no more tricks up its sleeve?