The consensus on shorting the yen is gradually forming: it may fall below the 160 mark in 2026, and the Bank of Japan's cautious policy struggles to resolve the dilemma

As the latest interest rate hike by the Bank of Japan failed to boost the exchange rate, Wall Street's bearish sentiment towards the yen has intensified, and the market is gradually forming a consensus that the yen will remain weak for a long time. Major institutional strategists, including JP Morgan and BNP Paribas SA, predict that due to the high US-Japan interest rate differential and negative real interest rates, the yen will fall below the 160 mark against the US dollar by the end of 2026, and may even decline further.

This year, the yen has recorded a slight increase of less than 1% against the US dollar, ending a four-year downward trend. However, the hoped-for combination of interest rate hikes by the Bank of Japan and rate cuts by the Federal Reserve has not brought the expected turnaround. Currently, the yen is hovering around 156, far from the 140 level it reached in April this year, and approaching the low of 158.87 at the beginning of the year, reflecting market disappointment with the effectiveness of the central bank's policies.

Strategists point out that the fundamentals of the yen are extremely weak, and cyclical forces may further turn against the yen next year. Although Japanese Finance Minister Satsuki Katayama and other officials have intensified verbal warnings, bringing intervention risks back into focus, the market generally believes that simple market intervention, in the absence of aggressive monetary policy support, is unlikely to fundamentally reverse the structural depreciation trend of the yen.

Overnight index swaps indicate that the market expects the Bank of Japan's next interest rate hike to be fully priced in only by September next year. This slow pace of policy normalization, combined with the resurgence of arbitrage trading and ongoing capital outflows from Japan, is depriving the yen of the key momentum needed for a rebound.

Weak Fundamentals Limit Policy Effectiveness

Wall Street's pessimistic forecasts for the yen stem from concerns about the fundamentals of the Japanese economy. Junya Tanase, Chief Japan FX Strategist at JP Morgan, holds the most bearish view on Wall Street, predicting that the yen will fall to 164 by the end of 2026. He points out that the fundamentals of the yen are quite fragile, and this situation is unlikely to change significantly as we enter next year. Cyclical forces may turn more unfavorable for the yen, and as the market prices in higher interest rates in other regions, the impact of the Bank of Japan's tightening policies will be limited.

BNP Paribas Emerging Asia FX and Rates Strategist Parisha Saimbi also expects the yen to reach 160 by the end of 2026. She analyzes that next year's global macro environment will be relatively favorable for risk sentiment, which typically benefits arbitrage trading strategies. Given the resilience of arbitrage demand, the cautious stance of the Bank of Japan, and the Federal Reserve's potentially more hawkish position than expected, the USD/JPY exchange rate is likely to remain high.

Capital Outflows Intensify Depreciation Pressure

In addition to the interest rate differential, the outflow of domestic funds in Japan has also become a significant obstacle to the yen's exchange rate. Data shows that the net amount of Japanese retail investors purchasing overseas stocks through investment trusts has remained near last year's ten-year high of approximately 9.4 trillion yen (600 billion USD), highlighting the household sector's continued preference for overseas assets Analysts believe that this trend may continue until 2026, further dragging down the yen.

The capital outflow at the corporate level seems to be more stubborn. Shusuke Yamada, Chief Japan Foreign Exchange and Interest Rate Strategist at Bank of America, pointed out in a report earlier this month that Japan's foreign direct investment has maintained a steady pace in recent years, largely unaffected by cyclical factors or interest rate differentials. In particular, the volume of outbound mergers and acquisitions by Japanese companies reached a multi-year high this year, further exacerbating the selling pressure on the yen.

The "arbitrage trade" of borrowing low-yield yen to invest in high-yield assets such as the Brazilian real or Turkish lira has re-emerged as a market resistance. Data from the U.S. Commodity Futures Trading Commission (CFTC) shows that as of the week ending December 9, leveraged funds' short positions on the yen reached the highest level since July 2024, and these positions were largely maintained in the following week.

Tohru Sasaki, Chief Strategist at Fukuoka Financial Group Inc., believes that the weak yen situation has not changed at all, with the key being that the Bank of Japan's interest rate hikes are not aggressive, and real interest rates remain deeply negative. He predicts that the yen will reach 165 against the dollar by the end of 2026 and points out that if the market begins to price in the end of the Federal Reserve's rate cuts, it will become another factor pushing up the dollar against the yen.

Intervention Difficult to Change Long-Term Trend

As the exchange rate approaches levels that previously triggered intervention, the risk of official intervention has once again become a focal point. Japanese Finance Minister Satsuki Katayama and other officials have intensified warnings against excessive speculation. However, Wee Khoon Chong, Senior Asia-Pacific Market Strategist at BNY, believes that the market remains turbulent, and simple "smoothing" operations may not change the depreciation trend of the yen. The recent focus of the market remains on the government's upcoming fiscal strategy.

Although Goldman Sachs believes that as the Bank of Japan normalizes its policy, the yen will eventually rise to around 100 in the next decade, it also acknowledges the presence of multiple negative factors in the short term. Against the backdrop of structural weakness that is difficult to repair in the short term, the downward path of the yen does not seem to have reached its end