Yen Bulls Lie in Wait for US-Japan Yield Gap to Shrink Next Year

(Bloomberg) -- After two straight years seeing bets on a yen rebound turn into the cold reality of further declines, some strategists reckon the third time will be the charm for Japan’s beleaguered currency.

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The likelihood of a series of interest-rate hikes from the Bank of Japan and further cuts from the Federal Reserve will drive the Japanese currency’s recovery to as far as 130 against the dollar, according to some. The projections come with a high degree of caution, given the yen’s volatility through 2024, and the difficulty of anticipating how Donald Trump’s return to the White House may impact Fed policy and global markets.

A stronger yen would reverberate across asset classes, creating a drag for Japan’s equities while boosting the capacity of the nation’s cashed-up companies to make acquisitions abroad. Investors would also be less inclined to use the currency to fund investments in higher-yielding alternatives overseas and may be more willing to funnel money home.

“The US is expected to keep cutting interest rates as shown in the Fed’s dot plot, and the BOJ is expected to continue raising interest rates about once every six months, leading to a narrowing of the rate differentials between the US and Japan,” Masafumi Yamamoto and Masayoshi Mihara, strategists at Mizuho Securities Co., said in a note last week. “Not all of Trump’s policies will lead to a stronger dollar.”

The strategists at Mizuho predict the yen to surge to 130 against the greenback by the end of 2025 — a level not seen since early 2023. Their peers at Nomura Securities Co. and Saxo Markets see it rising as high as 140. It traded at 154.42 at 3:30 p.m. in Tokyo on Monday.

The bullish outlook for the yen next year is in stark contrast to the current situation.

Hedge funds were the most bearish on the yen since August in the run-up to the US presidential election, data released this month showed. This was quickly followed by the dollar scaling its highest since November 2022 against a basket of currencies on a rush of so-called Trump Trades in which investors positioned for trade duties, lower taxes and deregulation.

Leveraged funds increased their bearish yen wagers in the week ended Nov. 12, with short positions at the highest since July, according to the latest Commodity Futures Trading Commission data.

“We see very near-term upside risk for dollar-yen, but expect yen strength in 2025,” said Yujiro Goto, head of foreign-exchange strategy at Nomura Securities Co. “The Fed and other major central banks are still cutting even under Trump.” Tariff concerns should support the yen relative to other currencies, he added.

Traders see a more than 80% chance of the Fed cutting rates by January, which offers potential relief for the yen. In-line inflation data last week helped soothe concerns on halting progress toward lower inflation on a Trump presidency.

Nomura’s Goto also noted that intervention risk and verbal warnings from the Japanese authorities may limit the upside risks of dollar-yen.

Japan’s chief currency official Atsushi Mimura has warned that the nation will take appropriate action against any excessive FX moves after Trump’s election win this month triggered a slide in the yen. Finance Minister Katsunobu Kato said last week that authorities were monitoring the market with a high sense of urgency and he repeated the warning of responding to any excessive moves.

Analysts say that while the dollar-yen is seen easing, it will not be a one-way trade. The uncertainties surrounding the pace of Fed rate cuts and Trump’s tariffs could create significant hurdles.

‘Major Wild Card’

“Our baseline is for the yen to rebound as US interest rates fall back gradually. But Trump’s election is a major wild card now,” said Alvin Tan, head of Asia FX strategy at RBC Capital, while adding that it will be tough for the yen to strengthen past 140.

Although the BOJ has said that it remains on a gradual rate hike trajectory, any dialing back of Fed easing expectations would weigh on the yen as well. Chair Jerome Powell said last week that recent economic signals mean the FOMC doesn’t need to hurry to cut rates.

The Fed has left open “the possibility that the US economy may run hotter than expected, or in any case inflation may be higher than expected, in which case the rate hikes previously priced into the yield curve get priced out,” said Naomi Fink, chief global strategist at Nikko Asset Management. “This means the interest-rate differential persists, which also means that the dollar remains in demand versus the yen, especially in a risk-on environment.”

Added to that, Japan’s capital outflows outweigh its current-account surplus, which is putting pressure on the yen. Mitsubishi UFJ Morgan Stanley’s end—2025 forecast for the yen is 154.50 against the dollar due to these risks.

Read: Yen’s Malaise Deepens as Capital Outflows Eclipse Record Surplus

While the BOJ gave no clear hint of a move next month in a summary of opinions from its October policy meeting, pressure is piling up for another rate hike. What may really move the dial for the currency pair is clearer signs of another rate reduction in the US.

The yen weakened 0.5% in choppy trading after BOJ Governor Kazuo Ueda in a speech on Monday avoided giving a clear hint on whether he would raise interest rates at the December meeting. The currency was later little changed following a question-and-answer session in which Ueda said the BOJ will make an appropriate decision in December based on data and risks.

“A further slowdown in the US economy, prompting Fed rate cuts” is what could take the yen down to the 140s, said Charu Chanana, chief investment strategist at Saxo Markets in Singapore.

--With assistance from Daisuke Sakai.

(Adds further comments from BOJ governor and yen’s movement Monday)

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