Why is the Japanese yen hovering near three-month lows against the dollar

The Japanese yen is hovering near three-month lows against the U.S. dollar, after hitting 153.18 late Wednesday.

In the past, weakness in the Japanese currency has been attributed to the difference between the U.S. and Japanese interest rates as lower rates tend to pressure currencies, while higher rates lift them up. Japan had negative rates for about eight years, keeping it's currency weak compared to the dollar.

But with the Federal Reserve lowering rates and the Bank of Japan raising them, that rate differential has narrowed. So why is the yen depreciating now?

Alvin Tan, head of Asia FX strategy at RBC Capital Markets said yen continues to be the "lowest-yielding G10 currency by far." The G10 refers to the 10 most heavily traded currencies in the world.

Therefore, holding a long yen position is costly because it offers a much lower interest rate than its counterpart in a currency pair, which could be the euro or the U.S. dollar.

"The annualised 1-month deposit rate for yen is +0.03%, while it is 4.76% for the U.S. dollar. That is why the yen can't strengthen consistently despite the Fed (or ECB) cutting rates. The rate differential against the yen is simply still too large for many investors to consider holding it for a long period."

Homin Lee, senior macro strategist at Swiss private bank Lombard Odier told CNBC the recent volatility in yen is also likely due to the market repricing the return of former U.S. president Donald Trump to the Oval Office, solid growth indicators in the U.S., as well as worries about the upcoming election in Japan.

He adds that continued volatile trading in the currency pair "might not be avoidable in the very near-term" due to elections in the U.S. and Japan.

However, any further weakness in the yen could trigger an intervention again by Japanese authorities, Lee said, pointing out that voters are still unhappy with the "extreme cheapness of the currency."

RBC's Tan thinks that global risk sentiment needs to weaken sharply in order for yen to strengthen, saying "the yen benefits when global market volatility spikes because it is the top safe haven currency."

The yen tends to weaken against the greenback during periods of risk-off sentiment — when U.S. yields rise while equities fall — Hugh Chung, chief investment advisory officer at wealth and fund platform Endowus told CNBC earlier this year in the aftermath of a volatile yen.

U.S. yields have indeed been rising, while stocks have taken a beating over the past few days, which appears to have triggered more than 1% depreciation in the currency on Wednesday.

The yen was last trading at 152.82 against the dollar.