The Japanese yen—which is tracking below where various fundamental drivers are implying it should be—could claw back ground over the year ahead, even against a relatively-firm US dollar. From our perspective, the currency should benefit from a confluence of factors.

Increased geopolitical, macro, and market volatility: A sustained increase in turbulence should enhance the yen’s counter-cyclical properties, giving it room to appreciate.

The yen typically benefits during periods of market turbulence.
Cross asset volatility, z-score, lookback to 2005
January 2016 – November 2024

Further policy normalisation by the Bank of Japan: The tightness in labour markets is feeding through to wages, and this is supporting underlying inflation. We expect the central bank to continue gradually removing the degree of policy accommodation still in place, helping to narrow yield differentials while putting a tailwind behind the yen.

Improved capital flow dynamics: Japan’s balance-of-payments position, a long-standing source of yen strength, has improved, with the current account surplus exceeding 4.5% of gross domestic product. Renewed trade-flow support might also be compounded by a reduction in capital outflows. After accounting for hedging costs, from a Japan-based investor’s perspective, offshore bond investments look somewhat unattractive.

The balance of payments position has improved dramatically.
Japan current account balance, % of gross domestic product
January 1997 – October 2024