The DXY US dollar index is standing tall after a late-week rally as all G-10 currencies appear to be under the weather this week. The yen, however, is basking in the glow of this week's risk-off mood, especially as emerging market equity indices seem to be having a bit of a meltdown. Perhaps as a consequence, the MXN/JPY carry trade has been taking it on the chin over the past fortnight, and it looks prone to further falls.

So what’s driving the dollar?

Election risks in the US have spiked, adding to the global risk-off atmosphere and reinforcing the US dollar as the go-to safe haven. With short-term US commercial paper paying over 5.25%, it's no wonder the dollar's got a spring in its step.

Besides the upcoming PCE inflation data, the major challenge for the US dollar's strength hinges on the Federal Reserve Board and how quickly it might have to cut rates. Emerging market risk-takers are likely crossing their fingers that the Fed brings out the scissors sooner rather than later.

On the USDJPY cross, momentum traders seem to have shifted from squaring short yen positions to taking long JPY bets ahead of next week’s Bank of Japan meeting. They're practically joined at the hip with Tokyo flows today, seemingly unfazed by Bloomberg's earlier dovish report about the BoJ being reluctant hikers.

I suspect the BoJ feels political pressure to move the yen in the right direction. While the latest LDP maneuvers haven't demanded a stronger yen, the smoke signals are there.

Many FX traders weren't ready for this turn, so we could see a significant move lower in USDJPY, especially if US stocks tumble. This could prompt a broader leverage clean-up on low-volatility trades like FX carry, where the yen would be the primary beneficiary.

Lower US yields, a narrowing UST vs. JGB differential, and a moody market suggest that the yen has plenty of room to hold onto its gains. However, next week's BOJ meeting will be the real deciding factor.

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