Much of investors' focus this week may have been on the rate decision by the European Central Bank (ECB), but Mansoor Mohi-uddin, Chief Currency Strategist at UBS Investment Bank, says the big event in currency markets already happened back in March, when the G7 nations staged a co-ordinated intervention to stem the yen's strength.
"By putting a ceiling on Japan's currency for the first time since the credit crunch began in 2007, policymakers have brought the yen carry trade back," he told CNBC this week.
The G7 move, Mohi-uddin explained, reduced the risk of volatility - which is a key supportive factor for the carry trade.
A carry trade is when investors borrow in a low yielding currency - in this case the yen - to fund investments in higher yielding assets elsewhere. The March 18 intervention triggered the gradual weakening of the Japanese currency, which has since lost about 8 percent against the U.S. dollar.
Also supporting the carry trade is Japan’s low interest rates, which Mohi-uddin expects will continue for a "very long period" of time, possibly through 2013. And as other central banks start to raise rates, Japanese investors will see more value in buying higher yielding foreign assets.
This dynamic will keep the yen weak against the dollar for the next one and a half years at least, Mohi-uddin added. "We now see dollar-yen ending this year at 90, and then that rate rising to 100 at the end of 2012."
Downside Seen for Euro-Dollar
The specter of more rate hikes from the ECB, meanwhile, has kept the euro at 14-month highs versus the U.S. dollar, levels which Mohi-uddin think is overdone.
"The market is pricing in too many rate hikes," he argued, saying that the current 1.40 euro-dollar range is "way above long term fair value." A more sustainable level should be in the 1.20 range, he added.
"With more than five rate hikes priced into interest rate markets over the next year in the Euro zone at a time when growth will be constrained by significant fiscal austerity, we continue to be very wary of euro-dollar at these elevated levels."