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Why the Yen's Star Is Fading

The yen was the top performing major currency in 2011, but what a difference a year makes.

Remember when everyone hated the dollar and the yen was a star currency? Funny how a few statistics and some smooth central bank moves can change all that.

The Bank of Japan warned for months that they would stem the yen's rise, and "with their most recent bout of quantitative easing, they've managed to do the job," says Tommy Molloy, chief dealer at FX Solutions, noting that the yen has slid dramatically since the Bank of Japan injected liquidity in the market. "I think the market is doing the heavy lifting for them now, and there's no reason this move in dollar yen can't continue," he told me.

Molloy makes no recommendations on currencies or currency trades, but he thinks investors who had been buying the yen as a play on a booming Chinese economy may be heading for the exits now that China's growth is slowing. He also says he is hearing from investors who want to use the yen to fund carry trades against higher-yielding currencies like the Australian dollar and the New Zealand dollar.

"The path of least resistance is upward for dollar yen," Molloy told me.

Strategists at Bank of America Merrill Lynch also have concerns about the yen's valuation. They argue that among other factors, a number of central banks are likely to reduce their purchases of Japanese assets, and they also believe investors are excessively worried about the prospect of a third round of quantitative easing in the U.S. According to BofA's model, the yen is roughly 30% overvalued relative to the dollar.

Your move.

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