The recent interest rate hike by the Bank of Japan failed to sustainably boost the yen, leading to a growing chorus of bearish views on the currency. This has further reinforced the notion that the yen’s structural weaknesses cannot be resolved quickly.
Strategists at JPMorgan Chase, BNP Paribas and other institutions believe that due to the still significant yield gap between the US and Japan, negative real interest rates and ongoing capital outflows, the yen could fall to 160 or lower against the US dollar by the end of 2026. They say this trend could continue as long as the Bank of Japan gradually tightens monetary policy and inflation risks from fiscal stimulus persist.
This year, the Japanese yen has risen slightly by less than 1% against the US dollar after four consecutive years of decline. Previously, the market expected that the Bank of Japan’s interest rate hike and the Federal Reserve’s interest rate cut would lead to a rebound in the yen, but the result was not satisfactory. In April this year, the yen briefly broke through 140 yen to the US dollar, but then the upward trend of the yen weakened due to the uncertainty of US President Trump’s tariff policy and the rising fiscal risks brought about by changes in Japan’s political situation. Currently, the yen is fluctuating around 155.70, not far from the year’s low of 158.87 reached in January.
Junya Tani, chief Japan foreign exchange strategist at JPMorgan Chase, said, “The fundamentals of the yen are quite weak, and this situation is unlikely to change much next year.” Tani is the most pessimistic about the USD/JPY exchange rate at the end of 2026, predicting it will fall to 164. He pointed out that cyclical factors may further exacerbate the yen’s depreciation next year, thereby limiting the impact of the Bank of Japan’s monetary policy tightening, as the market has already factored in the expectation of rising interest rates in other regions.
Overnight index swaps indicate that the Bank of Japan’s next interest rate hike will not be fully reflected in market prices until September, while the inflation rate remains above the central bank’s 2% target, putting pressure on Japanese government bonds.
Arbitrage trading has once again become a hindrance to the yen’s rebound. The popular strategy of borrowing low-yielding yen to invest in high-yielding currencies such as the Brazilian real or the Turkish lira has made it more difficult for the yen to rebound. According to data from the U.S. Commodity Futures Trading Commission (CFTC), as of the week ending December 9, leveraged funds’ bearishness on the yen reached its highest level since July 2024 and largely maintained these positions in the following week.
Parisa Sediqi, BNP Paribas’ emerging markets Asia foreign exchange and rates strategist, said that the global macroeconomic environment next year is “relatively favorable for risk sentiment, and typically we think such an environment is conducive to carry trade strategies.” She expects the USD/JPY exchange rate to rise to 160 by the end of 2026. She added that strong carry trade demand, the cautious policy of the Bank of Japan, and the possibility that the Federal Reserve may be more hawkish than expected could all keep the USD/JPY exchange rate at a high level.
Japan’s outward investment flows remain another source of pressure on the yen. The amount of overseas stocks net purchased by retail investors through investment trusts hovers around the ten-year high of 9.4 trillion yen (about 60 billion US dollars) set last year, highlighting the continued preference of households for overseas assets – analysts believe this trend may persist until 2026 and exert pressure on the yen.
Corporate capital outflows may be a more persistent driving factor. In a report earlier this month, Shuji Yamada, chief Japan foreign exchange and interest rate strategist at Bank of America Securities, wrote that Japan’s outward direct investment has continued to grow steadily in recent years, largely unaffected by cyclical factors or interest rate differentials. He particularly noted that the volume of cross-border mergers and acquisitions by Japanese companies this year has reached a multi-year high.
