Is the Japanese Yen's rally expected? Investment banks forecast that by 2026, the USD/JPY will fall back to the 140 level

Japan’s new Prime Minister, Sanae Takaichi, is promoting an active fiscal expansion policy. Coupled with the Federal Reserve’s continued rate hike policy, which faces ongoing adjustment pressures, the outlook for the yen exchange rate has begun to show signs of change. As of mid-November, the USD/JPY quote is around 156.60, having retreated from earlier highs.

Fed Policy Shift Sparks Yen Appreciation Expectations

Recent dovish remarks from Federal Reserve officials have increased market expectations for a rate cut in December to about 80%. According to Morgan Stanley’s strategic analysis, if the Fed implements consecutive rate cuts amid signs of slowing U.S. economic growth, the USD/JPY exchange rate could appreciate to single digits over the next few months.

Morgan Stanley’s forecast indicates that the USD/JPY exchange rate is expected to reach around 140 in the first quarter of 2026, then rebound to about 147 by the end of the year. Strategist Matthew Hornbach and others note that the current exchange rate has deviated from its fair value range. To return to fair value, the rate is expected to decline in the first quarter of next year, mainly due to falling U.S. Treasury yields which may suppress the yen’s fair value.

Japan’s Policy Stance and U.S. Economic Outlook Create a Tug-of-War

Morgan Stanley believes that Japan’s current fiscal expansion is not as aggressive as the market expected. It also anticipates that as the U.S. economy recovers in the second half of 2026, the resurgence in arbitrage trading demand will put downward pressure on the yen. Arbitrage traders typically borrow yen during low-interest periods to invest in high-yield assets, then close positions for profit when the economy improves.

Fund Managers Favor the Yen as Next Year’s Top Choice

A recent survey by Bank of America confirms the attractiveness of the yen for investment. In November, about one-third of roughly 170 fund managers surveyed expect the yen to outperform other major currencies next year, making it the best-performing reserve currency. Fund managers believe the yen is severely undervalued, and potential interventions by the Japanese government and central bank could create significant upside for the currency.

When evaluating yen assets, investors can also consider trends in other emerging market currencies. For example, 8,000 yen is approximately 18,000 TWD, reflecting the yen’s relative positioning against other major Asian currencies. This undervaluation leaves ample room for future appreciation adjustments.