The US dollar is strong, and the yen has broken through 158. The market is divided on the outlook for the Bank of Japan's policy.

Exchange Rate Hits Record Highs, Political Uncertainty Adds Pressure

Since the beginning of 2025, the USD/JPY has been on a strong upward trajectory. After breaking the 158 level on January 9, it rose to 158.20 by January 12, setting a new high for the year. Behind this momentum are both the dollar’s own strength and multiple uncertainties within Japan.

Japanese Prime Minister Sanae Yoshimura plans to push for the dissolution of the House of Representatives at the National Assembly on the 23rd. The House election is highly likely to be held on February 8 or 15. This political uncertainty has increased market concerns about Japan’s future policy direction, further weighing on the yen.

Fed Turns Hawkish, Supporting the Dollar

Another key driver of the dollar’s rise is the shift in Federal Reserve policy expectations. Although the US non-farm payrolls data for December showed only 50,000 new jobs—below market expectations—the unemployment rate unexpectedly fell to 4.4%, creating a mixed picture. Against this backdrop, market expectations for Fed rate cuts have significantly diminished. Currently, the probability of a rate cut in January is considered very low, with the first cut now delayed until June. This has notably boosted the dollar index.

Bank of Japan’s Rate Hike Plans Face Dilemma

Prime Minister Sanae Yoshimura has consistently emphasized implementing “responsible and proactive fiscal policy” to stimulate economic growth. This expansionary stance conflicts with the potential for the central bank to raise interest rates. Data shows that although nominal wages have increased, real wages (adjusted for inflation) continue to decline, with negative growth for 11 consecutive months since January 2025. This indicates inflation is still eroding residents’ purchasing power.

Mitsubishi UFJ Morgan Stanley Securities’ Chief FX Strategist Daisaku Ueno pointed out the risks of this policy dilemma: “The central bank is tightening while the government is easing, making it difficult for inflation to fall quickly.” Under this policy mismatch, the Bank of Japan’s rate hike process may face constraints.

Diverging Forecasts, Support for Both Bullish and Bearish Views

Market participants hold differing opinions on the future trend of the yen.

The bearish camp believes depreciation will continue. Mitsubishi UFJ Morgan Stanley Securities expects the yen to weaken to 160 by the end of 2026, while Fukuoka Financial Group predicts the exchange rate could fall to 165 yen per US dollar. Their logic is that the dollar’s strength is unlikely to reverse, and the Bank of Japan’s policies lag behind the economic reality.

Conversely, some institutions remain bullish on the yen. Nomura Securities forecasts the yen will appreciate to 140 by the end of 2026 (meaning USD/JPY drops to 140). The reason is that the Trump administration is expected to nominate a new Fed Chair in January 2026. Due to the leadership transition, the Fed’s rate cut cycle may be longer and more frequent than market expectations, which would weaken the dollar.

Mitsui Sumitomo DS Asset Management’s Chief Macro Strategist Masayuki Yoshikawa pointed out a potential turning point: “If concerns about delayed rate hikes by the Bank of Japan can be alleviated and domestic prices stabilize, narrowing the Japan-US interest rate differential could be key to the yen’s rebound.” In other words, once policy signals improve, expectations for yen appreciation could be reactivated.

Market Key Points

This round of yen depreciation is essentially the result of conflicting forces: dollar strength, lagging central bank policies, and political uncertainty. The future direction of the exchange rate will ultimately depend on whether Japan’s central bank and government can improve policy coordination and on the actual progress of Fed rate cuts.