The yen finally took out the 120.00 figure and did so with a vengeance as carry trade flows continued to weigh on the currency. With absolutely no foreseeable catalyst to an increase in Japanese interest rates and a strong possibility of US rates climbing to 5% by early spring is it any wonder that USD/JPY continues to trend higher? Yet, as many analysts have noted fundamental divergences are becoming more and more pronounced, most notably the difference between the direction of the Nikkei and the direction of the yen. How long one can rise while the other falls is not clear, yet surely we are close to a turning point in that relationship.  At present, the single greatest support to the USD/JPY is continued flow of capital into the US seeking higher yields. Should that dynamic change for any reason -- perhaps a slower than anticipated Christmas season or a brutally cold US winter that casts a freeze on consumer spending, the market can do a sudden about face and begin a massive round of carry trade liquidation. With dealers now heavily short the pair after this relentless rise, bids will evaporate and USD/JPY could plummet 500 points in a week much like EUR/USD did around this time last year. But all of these musings are nothing but sheer speculation on our part, as there is little fundamental evidence to justify a yen long. In the meantime, the mounting carry costs of such a position can quickly destroy trading capital, so the dictum for all faders remains -- be right or be out.

The euro on the other hand appears to have found a temporary bottom, as yesterday's ECB rate hike despite all the protestations from Mr. Trichet that it was not the start of a new tightening policy, has at least made a token effort at compressing interest rate differentials. Going forward the dollar will have to produce better and better results to generate additional buying momentum. 

Boris Schlossberg is a Senior Currency Strategist at FXCM.