Yen's structural tailwind could push USD/JPY below 160, MUFG says

MUFG says investors are underestimating a structural shift in the yen that could provide significant long-term support, as the Bank of Japan's tightening cycle marks a historic departure from decades of ultra-loose policy. USD/JPY traded near 162.40 on Friday, close to recent cyclical highs, with the pair holding above the 162 level despite growing expectations for further BoJ action.

"Investors are overlooking a structural shift that could provide significant long-term support for the yen," MUFG said in a note published Friday, as USD/JPY traded near recent cyclical levels. The assessment comes as the BoJ's policy normalization accelerates against a backdrop of persistent inflation and a tightening labor market.

The BoJ raised its policy rate in June to the highest level in more than 30 years, joining the European Central Bank in tightening even as the Federal Reserve and Bank of Canada hold steady. The Bank of Korea followed with a surprise 25-basis-point hike to 2.75% on July 16, its first increase since January 2023, underscoring the regional shift toward tighter policy. USD/JPY held above 162.00, with traders watching for potential intervention if the pair breaches the 165 level, according to options market data cited by Bloomberg.

A sustained yen appreciation driven by BoJ tightening would unwind significant yen-funded carry trade positions, potentially reducing demand for high-yield risk assets globally. It also signals a major shift in global monetary policy divergence that could impact dollar-denominated asset flows and emerging market currencies. The BoJ's next policy decision is scheduled for late July, with markets pricing further tightening as Japan's core inflation remains above the central bank's 2% target.

Carry Trade Risks Loom as BoJ Normalizes

The yen's role as the funding currency of choice for global carry trades means any sustained appreciation forces investors to cover positions. Open interest in yen-funded carry strategies has grown substantially since 2023 as the BoJ's initial rate increases were gradual and well-telegraphed. A more aggressive tightening path would change that calculus, potentially triggering deleveraging in emerging market currencies and high-yield bonds that have been financed with cheap yen.

The last time the BoJ surprised markets with a hawkish tilt — in July 2024 — USD/JPY fell more than 3% in a single session, triggering a broad unwind of risk positions across Asian and emerging market currencies. MUFG's assessment aligns with a growing consensus among currency strategists that the yen is undervalued on a purchasing power parity basis. The real effective exchange rate for the yen remains near multi-decade lows, suggesting significant room for appreciation as monetary policy normalizes.

The divergence between the BoJ and the Fed is narrowing. While the Federal Reserve has held its policy rate at 2.25% since the Bank of Canada's July decision — with Dallas Fed President Lorie Logan recently calling for "modestly higher" rates — the BoJ is moving in the opposite direction. This convergence reduces the rate differential that has kept USD/JPY elevated, with the 10-year U.S. Treasury yield at 4.55% after falling five basis points on Thursday following a softer-than-expected PPI print.

For Japanese exporters, a stronger yen presents a headwind to earnings, as a stronger domestic currency reduces the value of overseas profits when repatriated. The Nikkei 225 fell 2.8% on Thursday to 66,835.54, with technology and export-oriented stocks leading the decline amid broader global risk-off sentiment.

This article is for informational purposes only and does not constitute investment advice.