Yen weakness persists on fiscal worries and Fed rate-hike bets

2026-07-06

Yen weakness remains strong

In the foreign exchange market, expectations that the yen will weaken further remain entrenched. Alongside Japan’s fiscal risks, bets on an early U.S. rate hike are adding to selling pressure. Some market watchers now see the yen falling into the 170-per-dollar range if the 2027 fiscal year budget draft does not show a clear funding source.

On June 30, the yen fell against the dollar to the 162-yen range, its weakest level in about 39 and a half years since December 1986. The yen, which had been largely range-bound amid caution over further intervention by the government and the Bank of Japan, broke through a psychological milestone and weakened further into the latter half of the 162-yen range.

In the June U.S. employment report released on the 2nd, nonfarm payrolls came in below market expectations. That briefly prompted a pause in the dollar’s strength that had continued since June. Even so, the prevailing market view remains that yen weakness will continue over the medium to long term.

Basic policy guidelines become a yen-selling factor

A new focus in the market is yen-selling pressure stemming from the government's basic policy guidelines for economic and fiscal management and reform. In the draft presented by the government on June 30, wording on fiscal consolidation that had appeared in the previous year was removed. While the phrase 'ensuring market confidence' remains, Masahiro Ichikawa, chief market strategist at Sumitomo Mitsui DS Asset Management, said 'the funding source is unclear.'

Details on the scale of the budget and the funding source are expected to become clear toward year-end. Ichikawa said that if the budget scale expands further and concerns about aggressive fiscal policy intensify, that will become another factor pressuring the yen lower. He expects the yen to stand around 165 per dollar at year-end.

The draft also newly included the line that 'it is also extremely important that appropriate monetary policy management be carried out to realize a strong economy.' The market has taken this to mean the government may be seeking to restrain further rate hikes by the BOJ. If the BOJ forgoes a rate hike, expectations for a narrowing of the U.S.-Japan interest rate gap would recede, becoming a factor weighing on the yen.

Keiko Ninomiya, senior FX market analyst at SMBC Trust Bank, said 'an earlier pace of BOJ rate hikes is essential for a shift toward yen strength.' In addition to fiscal expansion, if the BOJ’s monetary policy falls behind, she sees the yen at year-end against the dollar at 'either just above or just below 158 yen, even if it moves in a stronger-yen direction.'

Intervention level seen near 165 yen

Market participants see yen-buying intervention by the government and the BOJ as having only a limited effect on supporting the currency, but as still capable of curbing one-way yen weakness. Many see the next intervention zone as around 165 yen.

Shusuke Yamada, chief Japan FX and rates strategist at BofA Securities, said 'it is hard to imagine allowing yen weakness beyond 165 yen to continue unchecked.' He added that 'even if that line is crossed and there is no intervention, it is often heard in the market that the yen could fall to 170 yen.'

However, a cut in the consumption tax, fiscal expansion and restraint on BOJ rate hikes are all being viewed as yen-negative factors. Tsuyoshi Sasaki, chief strategist at Fukuoka Financial Group, said intervening while rolling out policies that prompt yen selling would have 'almost no meaning.' 'Even if intervention were conducted in this situation, it would only delay a fall to 170 yen by one or two months,' he said.

Shou Suzuki, market analyst at Matsui Securities, said a drop to 170 yen is possible, though not his main scenario. He expects yen weakness to deepen if Fed rate hikes, backed by the resilience of the U.S. economy, and concerns that the BOJ is falling behind the curve in responding to inflation emerge at the same time.

Although the June U.S. employment report fell short of market expectations, Suzuki said 'it was not weak enough to erase expectations for Fed rate hikes. The view that the U.S. labor market remains solid has not changed.'

Equity gains invite yen selling

Rising Japanese shares, moving in contrast to the weaker yen, are also seen as a potential factor encouraging yen selling. Foreign investors sometimes pair purchases of Japanese stocks with yen selling to hedge currency risk. With stocks rising rapidly in recent weeks, the market is increasingly seeing the need for additional yen selling.

Yamada of BofA Securities said 'currency hedging is at the core of yen weakness.'

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