Why the Japanese Yen Remains So Weak: Insights and Market Analysis
Investing.com – Despite various economic factors that would typically support its strength, the Japanese yen (JPY) has persistently weakened, continuing to be the poorest-performing currency within the G10 group since early October 2025. This ongoing decline coincides with the tenure of Japan’s Prime Minister Sanae Takaichi and her administration’s economic policies.
Monetary Policy and Yen Performance
The yen’s slide has surprised many market watchers, especially given expectations that the gap in monetary policy between Japan and other major economies was set to narrow. However, the yen’s depreciation has persisted even as some interest rate dynamics have shifted favorably for Japan. Notably, the Federal Reserve’s more hawkish stance in recent meetings has, paradoxically, not translated into a stronger dollar-yen spread, as the expected rate differentials have increasingly leaned toward the yen’s advantage in recent months.
This unusual divergence suggests other forces are suppressing the yen’s value. Capital Economics’ Deputy Chief Markets Economist, Jonas Goltermann, points to Japan’s exceptionally low real interest rates as a partial explanation. Still, he highlights the significant disconnect between traditional interest rate differentials and the exchange rate’s actual movement.
Carry-Trade Dynamics and Fiscal Considerations
One considerable factor contributing to the yen’s weakness is carry-trade positioning. Investors continue to borrow yen, attracted by Japan’s low borrowing costs, to invest in higher-yielding assets abroad. This behavior exerts additional downward pressure on the yen. While similar patterns caused volatility last year—corrected by currency interventions, weaker U.S. economic data, and an unexpected rate hike by the Bank of Japan (BoJ)—the current carry trade positioning is less extreme but remains influential.
Some market participants have suggested that concerns over the government’s fiscal stimulus plans under Prime Minister Takaichi could be weighing on the yen. However, Goltermann argues that this is less credible given that Japan currently enjoys a small fiscal surplus and can undertake some degree of monetary or fiscal loosening without jeopardizing fiscal stability. Despite a rise in longer-term Japanese Government Bond (JGB) yields this year, they remain low by historical standards, especially amid Japan’s inflation normalizing.
Valuation Metrics and Possible Recovery Scenarios
From a valuation standpoint, the yen is significantly undervalued. Its real trade-weighted value has sunk to levels last seen in the 1970s. The currency’s undervaluation extends to purchasing power parity (PPP) measures, where it now stands as undervalued against the U.S. dollar to a degree unprecedented in recent decades among G10 currencies. Additionally, improvement in Japan’s terms of trade and a return to a large current account surplus add to the argument that the yen’s depreciation is not aligned with underlying economic fundamentals.
Nonetheless, undervaluation by itself is unlikely to spur a robust yen rebound without a strong catalyst. Goltermann notes that any meaningful recovery would need events or policies capable of shifting market expectations and unwinding carry trade positions. While currency interventions could provide temporary relief, their lasting impact would be limited without fundamental changes.
Looking ahead, Capital Economics identifies two potential triggers that could lead to a yen recovery: a global or U.S. economic downturn prompting widespread monetary easing, or an acceleration in BoJ’s policy normalization while other central banks continue to ease. The latter remains their baseline forecast, with projections suggesting the USD/JPY rate could fall to around 150 by the end of 2025 and approximately 140 by the end of 2026. Conclusion
The Japanese yen’s persistent weakness—even amid factors traditionally favorable to its strength—reflects a complex interplay of monetary policy divergence, carry trade dynamics, and market sentiment. While undervaluation indicates potential for recovery, tangible shifts in economic conditions or central bank policies will likely be necessary to prompt a meaningful rebound in the yen’s value.
Investors and analysts alike will be closely monitoring developments within Japan’s monetary policy framework, the global economic outlook, and investor positioning to anticipate future movements in the currency.