Yen Weakness Intensifies as Japan’s Fiscal Push and Policy Gaps Lift USD/JPY

The USD/JPY exchange rate has exhibited a clear upward trend, recently touching a one-week high. It then experienced a slight pull-back to around 151.74. This sustained yen weakness reflects a convergence of factors across global finance, domestic Japanese policy, and international relations. Traders must analyze these multifaceted pressures to forecast future movements accurately.

What are the Main Economic Factors Driving Yen Weakness in Recent Months?

Several core drivers underpin the yen’s weakness. First is the widening interest-rate and yield differential between the Bank of Japan (BoJ) and the Federal Reserve (Fed). Japan’s policy rate currently sits around 0.50%. Meanwhile, U.S. rates remain in the 4.25-4.50% range. This substantial gap encourages capital flows toward higher-return U.S. assets.

Secondly, the domestic fiscal environment in Japan is expansive. The incoming administration under Sanae Takaichi is preparing a large stimulus package intended to outpace last year’s ¥13.9 trillion (~US$92 billion) effort. This expansionary stance tends to increase government bond issuance. It also raises expectations of future inflation, which weakens the currency.

Thirdly, global capital flow and safe-haven dynamics favour the U.S. dollar. In times of geopolitical instability, investors seek the highest liquidity and highest-return safe havens. Right now, the dollar retains that status more than the Japanese yen. Finally, structural factors such as Japan’s relative technological stagnation and global supply-chain shifts reduce the yen’s attractiveness for medium-term foreign investment flows.

Domestic Japanese Fiscal Expansion

Japan’s new Prime Minister, Sanae Takaichi, is preparing an aggressive economic stimulus package. It is likely to exceed last year’s ¥13.9 trillion (~US$92 billion). This expansionary fiscal policy aims to counter rising inflation and support household incomes. Markets anticipated this policy shift, contributing to the yen’s roughly 2.6% decline this month. This is its most significant monthly drop since July.

A combination of significant fiscal spending and a challenging relationship with the central bank typically weighs heavily on a currency. With bond issuance expected to increase, long-term yields have already begun creeping higher. The 10-year Japanese Government Bond (JGB) yield has risen toward 1.6-1.7%, nearing levels unseen since 2011.

This set-up presents a dilemma for Japan. If the BoJ tightens too quickly, debt-servicing costs balloon. If it remains too lax, the yen remains weak, and import-cost inflation stays elevated.

Interest Rate & Yield Differential

One of the core structural drivers of the yen’s weakness remains the rate differential between the Fed and the BoJ. Historically, when Japan’s rates lag foreign peers, the yen loses value as investors seek higher returns abroad. The BoJ, having exited negative rates earlier this year and holding policy at 0.5 %, still trails major peers.

Despite this, recent commentary has flagged that the correlation between interest-rate spreads and USD/JPY is not as tight as before — sentiment, policy surprise risk, and fiscal flows are increasingly important.

The implication is that even if the BoJ begins to tighten, unless Japan closes the policy gap meaningfully or markets see credible commitment, the yen may continue under pressure.

Geopolitical Instability and Safe Havens

Global political risk typically favors the U.S. dollar. This cements its position as the world’s primary reserve currency. The ongoing U.S. government shutdown, now entering its third week, injects domestic uncertainty. This standoff complicates the Fed’s data-driven decision-making. It may reinforce expectations for rate cuts, which can weaken the dollar. Despite this, the dollar index (DXY) remains resilient at around 98.84.

A brief drop in gold prices recently triggered market volatility and a re-balancing of safe-haven assets. This allowed the yen to climb briefly. Yet the persistent U.S. political gridlock maintains a background risk premium that supports the dollar as the ultimate haven. In short, Japanese exports may benefit from a weak yen. However, global risk flows still favour the dollar.

Geostrategy and Technology Competition

Geostrategic competition, especially involving China, supports the USD through capital-flow redirection. Diversification and resilience strategies in global supply chains lead to investment shifts toward Southeast Asia and other strategic areas. Often, these flows bypass the yen.

Furthermore, the dollar benefits from high-tech and cybersecurity dominance, along with the associated intellectual property (IP), including patent families. These are key drivers of economic growth. A country’s strength in technology, quantified by international patents, significantly impacts its currency’s global competitiveness and valuation. This often bolsters the dollar’s perceived “soft power” relative to the yen.

In this context, Japan’s slower relative growth in next-gen technology sectors limits its appeal in global capital allocation. This reinforces structural yen weakness.

How Does Yen Weakness Impact Japan’s Export-Driven Economy?

A weak yen has a dual impact. On the positive side, Japan’s export-driven companies, such as automakers and electronics firms, benefit from more substantial competitiveness abroad. When the yen is weak, each overseas sale translates into more yen when repatriated. This can boost corporate profitability and shareholder returns.

On the downside, stronger exporters may face cost inflation from higher prices of imported raw materials and energy (priced in dollars). Household consumption may suffer as import-cost inflation drives up living expenses. Indeed, Japan’s economy expanded only about 0.6% in Q2 2025. Weak household consumption and soft Chinese demand weighed on growth. Core inflation stood at around 2.7%, above the BoJ’s 2% target, but it was primarily driven by import and energy costs rather than domestic demand strength.

Therefore, while a weak yen can stimulate growth via exports, it may also fuel inflation and reduce real incomes. This represents a delicate trade-off for policymakers.

Could Yen Weakness Lead to Inflationary Pressures in Japan?

Yes — particularly via higher import-cost pass-through. A weaker yen raises the yen-value of imported energy, food, and raw materials. This can elevate headline inflation even if domestic demand remains soft. Japan’s recent inflation (approx. 2.7%) is partly due to these external cost pressures.

Policymakers at the BoJ are closely watching whether wage growth becomes self-sustaining. In the 2025 “Shuntō” wage negotiations, base pay rose ~5.3% — historically high but still not enough in real terms. Gross earnings rose only ~1% year-on-year.

If the weak yen persists and wage growth accelerates, Japan could see inflation overshoot. This might force the BoJ’s hand toward tighter policy sooner than expected.

What Measures Can the Bank of Japan Take to Counter Yen Weakness?

The BoJ has a limited toolkit but several potential levers. These include:

• Raising policy rates or ending yield-curve control (YCC) to signal tighter monetary conditions.
• Conducting foreign-exchange intervention (buying yen, selling other currencies) is politically sensitive.
• Tightening monetary policy guidance and forward-guidance communication to change market expectations.
• Coordinating fiscal policy or “jawboning” with the Ministry of Finance (MOF) to stem speculative FX flows.

Recently, the U.S. Treasury Department urged the BoJ to continue tightening policy to support yen normalisation.

However, the BoJ remains cautious. Real GDP growth is still weak, inflation is driven primarily by costs (not demand), and debt service burdens are high. Drastic tightening would carry a significant risk. Markets expect a gradual path — perhaps a lift to 0.75% by early 2026, then a pause.

In What Ways Does Geopolitical Instability Reinforce Yen Weakness Relative to the U.S. Dollar?

Geopolitical instability tends to favour currencies currently seen as safe, liquid, and backed by deep capital markets with strong yields. This description fits the U.S. dollar more than the yen, despite Japan’s reputation for safety. Several reasons explain this: relative yield disadvantage, slower domestic growth, less attractiveness as a global investment currency, and expectation of continued BoJ accommodation.

For example, the ongoing U.S. government shutdown has caught the public’s attention. Still, it did not materially weaken the dollar. Partly, this is because global investors continue to prefer USD liquidity and yield over the yen. Safe-haven flows sideline the yen and strengthen the dollar, reinforcing the yen’s downside.

Why Does Expansionary Fiscal Policy Contribute to Yen Weakness in the Forex Market?

Expansionary fiscal policy tends to broaden a country’s budget deficit and increase government bond supply. In Japan’s case, if budgetary stimulus rises significantly without offsetting revenue increases, investors anticipate future inflation or currency depreciation. This weakens the currency.

Aggressive fiscal spending, combined with loose monetary policy, sends a signal that the currency is not being defended. This further erodes confidence. With the Takaichi administration signalling significant stimulus, markets interpret this as a factor supportive of yen weakness.

How Are Global Investors Responding to the Current Trend of Yen Weakness?

Global investors are acting in several ways:

• They are increasing short positions on the yen, favouring USD/JPY carry trades given the yield differential and expected policy divergence.
• They are reallocating capital away from Japan into higher-return emerging markets or U.S. equities, reducing yen-demand flows.
• Some monitor Japanese government commentary for possible intervention and hedge accordingly.

Analysis from Markets.com notes that market structure is increasingly important. Positioning, central-bank commentary, and hedging flows matter almost as much as interest-rate spreads.

Why Might Traders Expect Yen Weakness to Persist Despite Short-Term Corrections in the USD/JPY Exchange Rate?

Traders may expect yen weakness to persist because the structural drivers remain firmly in place. The yield gap, fiscal expansion, and global capital-flow dynamics are not about to reverse overnight. Even if short-term safe-haven flows or policy surprises cause temporary yen strength, the underlying fundamentals favour further weakness.

For example, the recent pull-back in USD/JPY after reaching a one-week high may reflect technical profit-taking or safe-haven rebalancing. However, unless the BoJ raises rates aggressively or Japan changes its fiscal stance, the medium-term trend remains dollar-positive.

Conclusion and Outlook

The primary drivers of USD/JPY’s ascent are the widening interest-rate differential, Japan’s expansionary fiscal outlook, and global capital-flow shifts favouring the dollar. While a short-term correction occurred due to safe-haven rebalancing, the structural forces remain dollar-positive.

The U.S. government shutdown presents a risk. However, its historical impact on the dollar has typically been modest and short-lived. Traders should expect USD/JPY to test new highs, especially if the new Japanese fiscal policy exacerbates bond-market concerns. Japan might eventually intervene if USD/JPY approaches 155-160, a level at which official concerns intensify.

From a trading-strategy perspective, positioning for trend continuation makes sense. Carry-trade opportunities, trend-following entries on USD/JPY breakouts, and hedges around JPY strength spikes caused by safe-haven reversal are key approaches.

In sum, unless Japan surprises markets by tightening significantly or reducing fiscal expansion, the yen’s weakness looks set to persist.