The triple driving forces behind the 34-year low in the Japanese Yen [2026 Trend Forecast]

The USD/JPY exchange rate hit a 34-year low in 2025, and the yen’s sharp decline has continued for about 10 months. This downward trend is not accidental but the result of multiple factors intertwining and colliding. Understanding the logic behind the yen’s plunge is crucial for assessing investment opportunities in 2026.

The Three Main Drivers of the Yen’s Sharp Decline

Policy Divergence Expanding the US-Japan Interest Rate Differential

The policy directions of the Bank of Japan and the Federal Reserve are polar opposites, becoming the primary force behind the yen’s rapid depreciation. In March 2024, the Bank of Japan ended its 17-year negative interest rate policy, raising the policy rate to 0-0.1%; then in January 2025, it more aggressively increased it to 0.5%. Meanwhile, the Fed maintained high interest rates and even signaled the possibility of further hikes, leading to an ever-widening US-Japan interest rate gap.

This widening interest rate differential has led to large-scale capital arbitrage: investors borrow low-interest-rate funds in Japan and invest in high-yield US assets. As long as US dollar interest rates remain higher than Japanese yen rates, the yen’s decline will persist.

Fiscal Policy Triggering Confidence Crisis

The aggressive fiscal policies implemented by Prime Minister Sanae’s administration have raised concerns about Japan’s long-term fiscal sustainability. When investors doubt the government’s debt repayment ability, demand for the currency naturally decreases, further accelerating the yen’s decline.

Self-Reinforcing Loop of Arbitrage Trading

The yen, traditionally known as an “arbitrage financing currency,” with its low interest rates, is favored for leverage trading. As the yen depreciates sharply, more investors jump into this trade, creating a self-reinforcing downward spiral. When USD/JPY broke through 157 in November, Japan’s Finance Minister issued a rare “strongest warning,” signaling the most aggressive intervention in the forex market since September 2022.

Can the Yen’s Decline Be Reversed? The Key Lies in These Three Points

Central Bank Policy Signals Are Most Critical

For the yen to truly stabilize, the Bank of Japan must send clear signals of an interest rate hike path. Market focus is on the December policy meeting: Will the BOJ raise rates? Will the Fed start cutting rates? These two variables will determine the fate of the yen’s decline.

US Economic Slowdown as a Critical Turning Point

Signs of slowing US economic growth are increasing the likelihood of the Fed initiating a rate cut cycle. If the dollar weakens, the yen’s sharp decline momentum will significantly diminish.

Technical Indicators Provide Clear Signals

In the short term, shorting on rallies below 156.70 is a relatively prudent strategy. If Japanese authorities intervene or the central bank establishes a clear rate hike path, USD/JPY could experience a cliff-like drop, with target levels possibly around 150 or even lower.

Institutional Forecast: Has the Yen’s Decline Peaked?

Morgan Stanley’s latest research report indicates that the USD/JPY exchange rate has deviated from its fair value. The bank predicts that as US economic slowdown drives down treasury yields, this deviation will be corrected in the first quarter of 2026.

Key Forecast Data:

• The yen is expected to appreciate close to 10% against the dollar in the coming months
• USD/JPY will fall to around 140 in early 2026
• If the US economy recovers in the second half of next year, the yen may face renewed depreciation pressure

Morgan Stanley emphasizes that although Japan’s domestic fiscal policies have not significantly expanded, external factors (especially the US economic outlook) will be the key variables driving the yen’s trend.

The Historical Roots of the Yen’s Decline: A 10-Year Review

The yen’s sharp decline did not start in 2024. Looking back over the past decade, several major events have shaped the long-term downward trajectory of the yen:

2011 Japan Earthquake and Energy Crisis

The Fukushima nuclear disaster created an energy shortfall, forcing Japan to import large amounts of oil, requiring forex sales to buy US dollars. At the same time, radiation fears hurt tourism and agricultural exports, sharply reducing foreign exchange income.

2013 Quantitative Easing Expansion

Under Governor Haruhiko Kuroda, the Bank of Japan launched unprecedented large-scale asset purchases, injecting the equivalent of $1.4 trillion into the market over two years. While boosting the stock market, the yen depreciated nearly 30% within that period.

2021 Fed Tightening

After the Fed began tapering its balance sheet, expectations for US dollar appreciation increased. Meanwhile, Japan’s ultra-low interest rate environment attracted arbitrage trading, adding pressure for the yen to fall sharply.

2024 Central Bank Policy Turning Point

In a countertrend amid global easing, the Bank of Japan raised interest rates, raising concerns about Japan’s economic outlook and increasing the risk of a sharp yen decline.

Four Key Indicators to Monitor for Yen Trends

Investors seeking to predict the yen’s future direction should focus on these key variables:

1. Inflation Rate (CPI)

Japan’s current inflation remains relatively low globally. If inflation accelerates, the BOJ has more room to hike rates, which is positive for the yen; if inflation falls back, the BOJ has less urgency to raise rates, and the yen may face renewed downward pressure.

2. Economic Growth Indicators (GDP and PMI)

Strong Japanese economic data suggest more room for the BOJ to tighten, supporting the yen; slowing growth requires continued easing, which is unfavorable for the yen. Currently, Japan’s economic performance among G7 countries is relatively stable.

3. Central Bank Statements and Policy Decisions

Every statement by BOJ Governor Ueda Kazuo can trigger market volatility. His recent comments about the yen’s weakness raising import costs have been interpreted as signals of potential rate hikes.

4. Global Central Bank Policies and Risk Sentiment

The policies of other central banks (especially the Fed) directly influence the yen’s relative value. Additionally, the yen has traditionally been a safe-haven currency, often surging during geopolitical crises.

Stage Conclusion

Although the short-term expansion of the US-Japan interest rate differential and the delayed adjustments in BOJ policies have kept the yen under pressure, the long-term logic supports the eventual return of the yen to its fair value. Investors should closely watch the March 2026 central bank meetings and US economic data as key signals for a potential yen reversal.

For those traveling or spending in Japan, consider staggered positioning; forex margin traders should develop strategies based on their risk tolerance and capital, implementing risk controls to navigate market volatility.