The yen has been the worst-performing major currency for the past two years, a trend that is expected to continue into 2026. Last week, the dollar rose above 159 yen, its highest level since July 2024.
Article by: Li Ruofan, Global Markets Strategist, DBS Hong Kong
Source: Hong Kong Economic Journal
The Japanese yen has been the worst-performing major currency for the past two years, a trend that is expected to continue into 2026. Last week, the dollar rose above 159 yen, its highest level since July 2024.
Nevertheless, it's worth noting that the yen has also experienced several rebounds in the past two years. The first round of yen appreciation against the dollar to around 140 occurred between July and August 2024, mainly due to panic selling of carry trades based on the yen. The second round of dollar depreciation against the yen to around 140 was primarily driven by increased safe-haven demand and a sell-off of dollar assets after "Liberation Day".
Since the end of 2024, non-commercial net positions in the Japanese yen held by the U.S. Commodity Futures Trading Commission (CFTC) and the Chicago Mercantile Exchange (CME) have turned net long, reaching a record high in April 2025. At that time, investor bearish sentiment towards the yen cooled significantly, even shifting to bullishness, primarily based on three expectations:
1) The Federal Reserve will cut interest rates significantly;
2) The Bank of Japan will continue to raise interest rates;
3) Japan may intervene in the foreign exchange market at any time.
However, since the second half of 2025, the situation has changed significantly.
First, the Federal Reserve's dovish stance was less than the market expected. Looking back to September 2024, the market anticipated a cumulative 2.5 percentage point rate cut by the Fed by the end of 2025. However, due to the resilience of the US economy and persistently high inflation, the Fed ultimately only cut rates by 1.75 percentage points. Looking ahead, although traders expect two more rate cuts this year, the dot plot released at the December FOMC meeting showed that Fed officials only expect one more rate cut this year. The latest unemployment rate, initial jobless claims, and inflation data also suggest that the Fed is unlikely to suddenly shift to a more dovish stance. Several Fed officials, including Raphael Bostic and Austan Goolsbee, have reiterated their concerns about persistently high inflationary pressures, further confirming this assessment.
Secondly, the Bank of Japan's pace of interest rate hikes has been significantly slower than market expectations. Since mid-2024, the Bank of Japan has only raised interest rates three times, in July 2024, January 2025, and December 2025, meaning a long interval between rate hikes. Political factors also present greater obstacles to further rate hikes by the Bank of Japan. Last week, Japanese Prime Minister Sanae Takaichi officially stated her plan to dissolve the House of Representatives as soon as possible after the regular Diet session on January 23, with the market expecting a snap election as early as February 8. Since Takaichi's approval ratings may help the Liberal Democratic Party win a majority in the House of Representatives, the market has begun to speculate that "Abenomics" policies may be restarted. Overall, the Prime Minister's move has exacerbated market concerns about Japan's fiscal situation and pushed up Japanese government bond yields. Aggressive rate hikes would not only increase Japan's massive public debt burden but could also exacerbate volatility in the Japanese government bond market. Currently, the market generally expects the Bank of Japan's next rate hike to likely occur in the second half of this year.
Third, the Japanese government is unlikely to take actual foreign exchange intervention action in the short term. This is mainly because the dollar's appreciation against the yen over the past month, as well as the one-month implied volatility of the currency pair, are significantly lower than levels before intervention in 2024. Specifically, the dollar has appreciated by about 3% against the yen over the past month, while previous monthly appreciations were typically between 5% and 6%; meanwhile, the one-month implied volatility of the dollar against the yen is currently around 8.5%, while it had previously exceeded 10%. If strengthening verbal intervention can effectively alleviate the depreciation pressure on the yen, then the necessity for actual intervention will also decrease.
In short, as several previously anticipated positive factors for the yen have not materialized as expected, the USD/JPY pair still faces the risk of retesting the 160-162 range (the 2024 high) in the short term.
