A lot of people are worried about the sinking Japanese yen and soaring Japanese bond yields. Prime Minister Sanae Takaichi and Bank of Japan Gov. Kazuo Ueda don't seem to be among them, even though renewed hostilities between the U.S. and Iran threaten another energy shock for one of the world's biggest oil and gas importers.
The yen has slumped 4% against the dollar over the past two months, crashing through a presumed 160 red line to hit a 40-year low below 162. Veiled threats of intervention have worked only momentarily. Yields on 10-year bonds, or JGBs, have nearly doubled this year to reach almost 2.9%.
That's high enough for Japanese fixed-income investors, who have more than $2 trillion parked overseas, to earn more at home figuring in currency hedging, says Rory Green, who follows Japan for TS Lombard. Signs of repatriation are faint, however. "They are afraid to catch falling knives," he says.
The outlook is for further declines so long as Takaichi keeps talking about spending increases and tax cuts, and the BoJ maintains a creeping pace of interest-rate normalization. Ueda and colleagues hiked by a quarter of a percentage point last month to 1%, lagging behind 2027 inflation expectations north of 2%.
"There isn't even a small sign that the government or central bank is willing to change tack," says Nick Verdi, a global rates and FX strategist at TCW.
Tokyo's high command has its reasons, says Ed Al-Hussainy, global rates strategist at Columbia Threadneedle Investments. "Japan's policymakers have done a really good job with very experimental policies," he says.
Takaichi's commitment to cheap money and weak currency is manna for the Japan Inc. export engine, Verdi notes -- one reason why stocks keep outperforming the S&P 500 even in dollar terms. But the BoJ needs to tread cautiously not to choke off growth and return Japan to deflationary lost decades, adds Shigeto Nagai, head of Japan economics at Oxford Economics. "They want to wait six months between hikes to see the effect on the economy," he says.
Markets may not grant that luxury this time. BoJ inaction at its next meeting in September could push the yen past 165, Green predicts. That might spark more inflation than Japanese voters bargained for when they handed Takaichi a historic victory last year. Ten-year bond yields breaking past 3% is a more likely trigger for a policy course correction, raising the cost of financing Japan's enormous sovereign debt, Nagai thinks. "Even Takaichi-san cares about JGB rates," he says.
Renewed closure of the Strait Hormuz would create a "perfect storm" for Takaichi and Ueda, Verdi adds. The U.S. Federal Reserve and other central banks could raise rates to head off energy inflation, sucking more capital out of Japan.
The vicious cycle for the yen and JGBs could in theory turn virtuous if the BoJ makes some haste toward a "terminal rate" between 1.5% and 2%, and Takaichi uses her popularity to lay off populist economics. Investors will watch closely in coming months as her government affixes hard budgetary numbers to her monumental pledge of Y370 trillion ($2.3 trillion) in public-private strategic investment over the next 15 years.
"Once the JGB rate stabilizes, domestic investors will increase their purchases," Nagai says. And perhaps they'll cut back purchases of U.S. Treasuries, of which Japan is the largest foreign holder with about $1.2 trillion.
No one's holding their breath for that just yet, though.
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(END) Dow Jones Newswires
July 09, 2026 10:13 ET (14:13 GMT)
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