The Fed's caution on rate hikes has made for an interesting dance between the dollar and the yen.
The move in the currency pair has gathered some momentum and it's a factor that will be watched across financial markets Thursday. There is little U.S. data, with just weekly unemployment claims at 8:30 a.m. EDT and consumer credit at 3 p.m. EDT.
On Wednesday, the dollar fell below the key 110 yen level for a second day and dropped as low as 109.35, a level last seen in October 2014.
Jeremy Klein, chief market strategist at FBN Securities, said it was the speed and magnitude of the pair's move that caught investors' attention.
"Once the dollar/yen got in reach of 110 in the last week or so, that got people [nervous over] implications of what Japan's moves are going to be," he said. Klein said it raised the question of whether the weakening dollar and rising yen could trigger the next move in the "currency wars." Some traders have been speculating about an intervention by Japan to weaken the yen.
The yen is more than 2.5 percent higher against the dollar since the Fed's March 16 meeting, where the central bank held off on an interest rate hike and issued a dovish statement. The dollar is also down 1.5 percent against the euro in that time. Dollar weakness has been somewhat of a plus for risky assets, lifting U.S. stocks and also helping oil prices.
"Certainly the dollar weakness has relieved some stress on multinationals. It's like the flavor of the day. In 2013 and 2014, the market loved the weak yen. Now all of a sudden, they love the strong yen and that's the same case with the stronger euro," said Peter Boockvar, chief market analyst at Lindsey Group. "The weaker dollar – all it's doing is releasing a pressure point markets were worried about."
As the dollar weakened Wednesday, oil and stocks rose. The S&P 500 was up 21 points at 2,066, helped by energy, and the Nasdaq, buoyed by a biotech rally, climbed 1.6 percent to 4,920. The dollar index was down 0.2 percent at 94.457.
"We think there's a bit more room to the downside. We have a target of 1.08 on dollar/yen," said Vassili Serebriakov, currency strategist at BNP Paribas.
"I think it's going to be a combination of risk deteriorating a little bit, and also U.S. real rates are low as the Fed remains dovish for now. We think that should keep the momentum going for dollar/yen,"
But it's the consequences of the currency moves that some strategists worry could become troublesome, and there's also concern about whether the move is a signal of something more dire for the global economy.
"Usually the yen is up when equities are down. So, we had a decoupling of that and now it's just a momentum trade," Boris Schlossberg, managing director, foreign exchange strategy at BK Asset Management, said.
Schlossberg said the yen usually strengthened when investors did not want to hold risky assets.
"The 110 was a very significant level it broke. It did a lot of technical damage. The yen is sort of toxic at this point…The sentiment is so sour, the market is very skittish," said Schlossberg.
To stop it, "the Fed has to signal a tectonic shift in its policy. Then I also wonder if there's an underlying fear that the Fed's reticence to hike is hiding something more serious in the global economic landscape, and the yen strengthens when there's a risk aversion."
The rising yen has weighed on Japanese equities, which were down for a seventh straight session Wednesday, and off 17 percent year-to-date.
The yen started to move higher when the Bank of Japan turned to negative interest rates in late January. The dollar previously had been moving higher as investors weighed easy policy in places like Japan and Europe, against the Fed's intention to hike interest rates.
"To me, this is a really dangerous game the markets are playing," said Boockvar. "I think what the Bank of Japan did backfired and I think people are realizing we reached limits with the Bank of Japan and the ECB [European Central Bank] and maybe there's nothing left for them to do if this is the response they're going to get."
The dollar moved to its low of the day against the yen after the Fed minutes were released Wednesday afternoon. The minutes showed how the Fed debated over how to respond to the slower economy. According to the minutes, some officials warned during the two-day meeting that delaying rate hikes could be a risk, while others wanted to proceed cautiously because of global risks.
Fed Chair Janet Yellen was in the cautious camp and she laid out the risks she saw in a speech last week. Her speech surprised some Fed watchers and was viewed as even more dovish than the Fed's post-meeting statement. That also added to the dollar's downward move.
The futures market indicates that investors do not expect a rate hike until late in the year or next year. The Fed adjusted its outlook for interest rates in March and now sees two rate hikes as possible this year, down from its earlier forecast of four.
While markets are heavily focused on the Fed, there should be strong interest in a historic gathering of Fed chairmen late Thursday afternoon. Yellen and former Fed chairmen Ben Bernanke, Alan Greenspan and Paul Volcker will appear together at 5:30 p.m. EDT for a program entitled "When the Fed speaks, the world listens."