The Yen conundrum

The Japanese yen has reached the weakest level vs the US dollar in 4 decades. This marks a continuation of a multi-year trend of yen depreciation that began intensifying around 2022, with only temporary relief from interventions and modest Bank of Japan (BOJ) tightening. Several interconnected factors explain the ongoing pressure: (1) Interest Rate Differentials va the US. The BOJ has raised its policy rate gradually, reaching 1.0% in June (highest since 1995), but this remains far below the US Federal Reserve’s range (around 3.5–3.75%). (2) Fiscal Policy Concerns Under Prime Minister Sanae Takaichi who has pursued expansionary “Sanaenomics”-style policies: large spending increases (e.g., defense, tech, infrastructure), tax cuts, and stimulus totaling several percent of GDP. This has raised fears of fiscal dominance; massive government debt (already the highest among developed nations, with net debt-to-GDP around 130%) being monetized or leading to higher deficits without sufficient discipline. (3) External Shocks and Trade Vulnerabilities: Japan imports nearly all its energy, especially oil from the Middle East. The Iranian conflict has pushed oil prices higher, increasing dollar demand for imports and weakening the yen. (4) Structural and Inflation Factors: Japan’s shift from deflation to moderate inflation (partly cost-push from energy/import prices) has complicated policy. Real interest rates remain very low/negative, limiting the yen’s appeal. As a response, the BoJ has hiked rates and has spent more than $70Bn defending the weakening of the Yen. We will likely see fa other intervention soon to avoid uncontrolled collapse of the currency, although both government and the BoJ are in a very tough spot. If that wasn’t enough, all fiat currencies are losing purchasing power, as you can see in the lower chart below. And the yen is the one that’s losing the most. The Japanese currency is quickly becoming a source of volatility and instability for the global economy.

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