For decades, Japan 's economy was marked by low indicators in interest rates, inflation, and GDP growth – all close to zero – weapons used to prevent the growth of Japanese debt, which is 260% of GDP, the highest among developed countries.
Signs of a crack in this macroeconomic stability began to become clearer on Tuesday, June 30, with theyen suffering a record devaluation of 38% - the largest in 40 years - accumulating a drop of more than 3% for the year.
The effects of this weakening of the Japanese currency led the market to recall Japan's massive intervention in the yen in August 2024, which triggered not only the largest single-day drop in Japanese stocks since 1987, but also a spike in US market volatility and a 6.1% three-day decline for the S&P 500.
There are crucial differences that separate the two major devaluations of the yen in two years. Behind the new low of the Japanese currency, trading at 162.41 yen per dollar, are recent events, such as the sudden rise in oil prices caused by the war with Iran - fueling doubts about the ability of Japanese authorities to control inflation.
Furthermore, the appreciation of the dollar against other strong currencies, the recent rise in the Japanese stock market (as opposed to a fall in 2024), and recent changes in the fiscal and monetary policies of the Asian country – announced within a few days of each other – ended up contributing to the devaluation of the yen.
This process began to take shape on June 16, when the Bank of Japan, the Japanese central bank, announced an increase in the interest rate to 1% — the highest level since 1995. The decision was a way to stem the record US$72 billion drain from the Ministry of Finance to defend the Japanese currency during the fall between the end of April and the last days of May, when the yen surpassed the 160 mark against the dollar for the first time.
Ten days later, on June 26, Prime Minister Sanae Takaichi unveiled plans for a massive public and private investment program for economic growth equivalent to US$2.3 trillion over 14 years.
The relative lack of detail on how the funding would be distributed, however, has reignited concerns about a potential increase in inflation, in addition to the plan putting Japan on the path to greater fiscal expansion. Japan's total public debt is currently between US$9 trillion and US$10 trillion.
The Japanese yen's exchange rate above 162 yen per dollar serves as "yet another reminder of how weak the yen has become," says Lee Hardman, senior currency analyst at Japanese asset manager MUFG, linked to the Mitsubishi Group. "The energy price shock has pressured the currency, and the Fed's update to its aggressive monetary policy is now encouraging higher interest rates in the US and a stronger dollar."
In practice, analysts assure that the Bank of Japan's monetary policy is very disconnected from what is happening in the US and Europe, which should keep the yen weak for a long period - despite the interest rate reaching 1%, investors expect only a further increase of just 0.25 percentage points from the Japanese central bank in interest rates until January.
Therefore, the government's promise to inject fiscal stimulus into the productive sector without any change in monetary policy risks overheating the Japanese economy. In parallel, the recent surge in the Japanese stock market has served as a source of downward pressure on the yen.
Since the beginning of the year, the Nikkei 225 index has broken a series of records, surpassing 72,000 points last week, in a move driven mainly by foreign investors who invested in artificial intelligence and semiconductor companies.
Carry trade
The devaluation of the yen coupled with the appreciation of the dollar against other strong currencies has caused the market to revert to the scenario of 2024, when the yen plummeted, but for different reasons – the insistence of the Japanese central bank on maintaining extremely low interest rates.
The gap between interest rates in Japan and the US at the time further boosted a traditional financial tactic in the country – the carry trade , a strategy in which an investor typically borrows cheaply in yen and invests the funds in higher-yielding assets in dollars.
“The yen carry trade is the global liquidity lever that almost no one notices until it moves,” says Michael Gayed, portfolio manager at The Free Markets ETF, an investment fund focused on American companies. “And all the conditions that made it dangerous in the summer of 2024 — a large interest rate differential, a yen around 160, and a central bank that needs to keep tightening monetary policy — are present again in the summer of 2026.”
Chris Turner, global head of markets at the financial conglomerate ING, believes Japan may react with a new round of yen purchases on Friday, given the low liquidity in the markets due to the July 4th holiday, or wait until shortly before the next Japanese holiday — Maritime Day — on July 20th.
“However, Japanese authorities will understand that intervention can only attempt to slow, not reverse, the current upward trend of the dollar against the yen,” he said. “A reversal would require not only drastic increases in interest rates by the Bank of Japan, but also a change in the overall trend of the dollar.”
