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Yen drops sharply, puzzling traders

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The yen fell to its weakest against the greenback since 2002 on Tuesday, piercing a key psychological level and puzzling traders.

With Bank of Japan (BOJ) rhetoric largely neutral and recent data pointing to stabilization in the economy, "the latest dollar-yen move is a surprise," Nizam Idris, head of strategy, fixed income and currencies at Macquarie, told CNBC on Tuesday.

The greenback was fetching as much as 125.07 yen in intraday trade, breaking the key psychological level of 125 for the first time since November 2002 without a major trigger, before the pair retreated to around 124.60. The currency pair has traded in a narrow range for most of the year – between 117 and 120.

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Sean Callow, senior currency strategist at Westpac Bank, was also somewhat perplexed by the move, chalking up the yen's latest bout of weakness to two main factors: speculators rebuilding short yen positions and Japanese investors stepping up purchases of foreign bonds in recent weeks.

Net purchases of foreign bonds totaled 2.4 trillion yen ($19.4 billion) in the first three weeks of May, according to data from the Finance Ministry as Japanese turn to overseas assets that offer higher returns, such as U.S. Treasurys.

Next stop: 130?

But further upside in dollar-yen will require a "new story," say analysts.

"The move so far has been based on soft triggers like position rebuilding. It's moved a lot on very little," said Idris. "The market tends to be rational after some time, so we should see some consolidation in the currency pair."

Idris, who sees dollar-yen at 128-130 by year-end, expects the "new story" will either come in the form of weak data or dovish signals from the central bank.

However, he acknowledges that with the yen at current levels, the BOJ won't be in a hurry to introduce further easing for the time being.

Watch the U.S. dollar

Callow says fresh drivers for dollar-yen are unlikely to be domestic.

"We'll probably need better data out of the U.S. to really drive substantial gains in dollar-yen," Callow said, adding that he's closely watching nonfarm payrolls data due out on Friday for fresh clues on the health of the world's largest economy.

"With prospects of stronger U.S. growth, you can't dismiss 130 as a target," he added.