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Investing.com -- The Japanese yen (JPY) has continued to struggle even as some of the factors that typically support the currency have been moving in its favour.
Despite expectations that the monetary-policy gap between Japan and other major economies will narrow, the yen has continued to slide and is now the worst performer in the G10 since Sanae Takaichi became prime minister in early October.
Her commitment to continued loose policy, alongside the Bank of Japan’s (BoJ) decision to again delay its next rate hike, has reinforced comparisons with the early Abenomics years, when the currency depreciated sharply.
According to Capital Economics, the persistence of the yen’s weakness is puzzling because interest-rate dynamics have not clearly turned against Japan. Even with the Federal Reserve sounding more hawkish in recent meetings, the expected rate gap between the U.S. and Japan has shifted significantly in favour of the yen in recent months.
Yet the currency has continued to weaken. Exceptionally low real interest rates in Japan help explain part of the disconnect, but the scale of the divergence between rate differentials and the exchange rate remains unusual, Jonas Goltermann, Deputy Chief Markets Economist at Capital Economics, said in a report.
Carry-trade positioning is one contributor. Favourable conditions have encouraged investors to borrow in yen to fund higher-yielding positions elsewhere, putting additional downward pressure on the currency.
Goltermann notes that a similar wedge opened last year and closed quickly when the carry trade unwound after currency intervention, weaker U.S. data, and a surprise BoJ hike. Positioning is not as stretched now, but still likely part of the story.
Some investors have also pointed to fiscal concerns tied to Takaichi’s stimulus ambitions. Goltermann sees this as less convincing, arguing that Japan currently runs a small fiscal surplus and can afford some loosening.
“While long-term JGB yields have risen significantly this year, they are still low in absolute terms, especially given that inflation in Japan finally appears to be normalising,” Goltermann wrote.
On longer-term metrics, the economist highlights how deeply undervalued the yen has become. In real trade-weighted terms, the currency is at its weakest point since the 1970s. Japan’s terms of trade, which deteriorated sharply during the 2021–22 energy shock, have improved, and the current account has returned to a large surplus.
On the OECD’s PPP measure, the yen is now “about as undervalued relative to the dollar as any G10 currency has been since the 1970s.”
Still, Goltermann argues that undervaluation alone will not drive a rebound. A meaningful recovery requires a catalyst strong enough to shift expectations and unwind carry positions. Intervention might offer temporary relief, but without fundamental change, its impact would be limited.
More powerful triggers would include a U.S. or global downturn that forces broad monetary easing, or the BoJ accelerating normalisation while other central banks continue to cut.
That second scenario remains Capital Economics’ base case. The firm expects the yen to regain some ground, forecasting USD/JPY at roughly 150 by year-end and about 140 by the end of 2026.