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Currency watch: views on the yen
With Nikkei and CNBC reports suggesting that a 200 yen/dollar level or above is a possibility, Mark Dowding gives his views.
We retain a relatively constructive view on the Japanese economy on a medium-term basis. We believe that deflation is now well behind Japan and that inflation looks to reach a point where it is broadly stable around 2%. This year’s Shunto increase close to 6% showed how higher inflation is translating into higher wages and we expect this to feed consumption. With firms paying higher wage costs we see this passed on in terms of higher prices and this, in turn, should guarantee that the CPI continues to exceed 2% for the next several years with wages continuing to grow at a healthy pace.
This move towards reflation is also leading to more bullish sentiment in Japanese stocks and parts of the property market. With Japanese households sitting on a lot of cash, we see a picture of the ‘lost generation’ starting to rise up and this should also help to underpin economic revival. This is further helped by structural reform across the corporate sector and attitudes changing in society, such as with respect to immigration.
This economic view means we expect that the BoJ will normalise policy over the coming year. We think that R* in Japan is around 1.5% and we look for cash rates to reach this level by March 2026, with 10-year JGB yields rising to 2% currently. Over the same period, we would look for the US economy to slow somewhat from recent strength, as rates staying higher for longer weigh on economic activity. This said, we don’t expect a US recession and would have US interest rates around 4% in March 2026.
Based on this we would look for the yen to appreciate over the medium term. The yen is very undervalued on many measures. Anecdotally, I find I can pay yen 700 for a beer in Tokyo and USD14 for the same in the US! Therefore, on a medium-term view looking ahead two years, we can see US$/yen back closer to 130.
However, in the short term, the BoJ continues to run very accommodative monetary policy, and this is undermining the yen’s valuation. Until interest rates start moving higher, this could see the yen weaken further and another test of 160 is possible in the wake of the recent BoJ meeting, unless if global yields are falling (either due to much weaker US data) or due to a risk off event (as could be triggered by politics in France). Meanwhile, a move as high as yen 200 seems very unlikely unless that Japanese authorities make a major policy error.
From our perspective we would like to be long yen, in line with our medium-term view. However, it is costly to own the yen, due to the carry differential. Therefore, we feel we must wait until the BoJ is much clearer in terms of taking policy action before we add a position.
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