The yen's safe-haven aura rapidly fading

For more than a month, as U.S. and Israeli military strikes on Iran have heightened global market risk-aversion sentiment, the foreign exchange market has shown a completely different picture from past experience: the Japanese yen, which used to strengthen as a safe-haven currency, has not performed the way it had in the previous several crises. The yen has kept sliding against the U.S. dollar, even breaking through the key psychological level of 160 yen per dollar and hitting a new two-year low. Once seen as a “safe haven” for capital, the yen’s halo is rapidly fading under the dual pressure of a worsening international geopolitical crisis and Japan’s domestic economic structural contradictions.

This shift is first rooted in the enormous uncertainty caused by Japan’s domestic macroeconomic policy overreach. The fiscal expansion policy introduced by the Hayaichi Sanae administration at the end of 2025 pushes the size of the 2026 fiscal-year budget to a high of 122.3 trillion yen, with nearly a quarter of it relying on newly issued government bonds. The ratio of Japan’s total government debt to its gross domestic product (GDP) has already exceeded 260%. This kind of fiscal approach—lacking a clear source of funding and relying on “issuing debt to pay for debt”—has severely shaken international market confidence in Japan’s fiscal sustainability and stability of the yen’s value, creating the biggest crack in the yen’s credit foundation.

The deeper shock comes from Japan’s energy vulnerability in its economy. As a resource-poor island nation, Japan imports more than 90% of its crude oil, and most of it must be transported through the Middle East. If passage through the Strait of Hormuz is disrupted, international oil prices would surge immediately—an input-inflation “storm” for Japan. Rising oil prices worsen Japan’s terms of trade, meaning Japan needs to pay more yen to exchange for dollars to buy energy, thereby deepening the trade deficit and putting persistent downward pressure on the yen exchange rate. Research from Nomura Research Institute indicates that this crisis may pull Japan’s real GDP down by 0.65% while also pushing up prices by 1.14%. When local conflicts directly damage the economic fundamentals of Japan, capital will not only fail to flow into the yen as a refuge; it may instead accelerate its flight because of Japan’s economic fragility.

Market preferences that support a stronger yen have changed. In the past, when global risk rose, Japan’s large overseas corporations and investors would repatriate profits and assets on a massive scale back to the domestic market, creating strong demand for the yen. Some analysis suggests that after the pandemic, Japanese companies are more inclined to keep funds overseas for reinvestment or allocation rather than to rush back when a crisis hits. This change has deprived the yen of a substantial portion of its endogenous support. When external shocks arrive, without hedging from domestic capital repatriation, the yen is more vulnerable to one-way selling pressure.

The large interest-rate differential between the U.S. and Japan exerts sustained depreciation pressure on the yen. In recent years, U.S. interest rates have stayed at relatively high levels, spawning a large amount of carry trade activity: investors borrow low-cost yen, exchange it into U.S. dollars or other high-yield currency assets, and earn the interest-rate spread. After the Bank of Japan raised rates at the end of 2025, its policy rate was only 0.75%, leaving a spread of up to about 3%—or even more—between it and the U.S. federal funds rate. In times of global turmoil, closing out these trades may provide a temporary boost to the yen. But in most cases, the very existence of the spread acts like a magnet, continuously drawing capital out of Japan and exerting a long-term, fundamental suppression on the yen.

Under this complex situation, the Bank of Japan’s monetary policy faces a dilemma, weakening its ability to support the exchange rate. On one hand, to curb imported inflation and support the yen, the Bank of Japan needs to tighten monetary policy and accelerate the pace of rate hikes. The minutes from the March meeting of the Bank of Japan show that some members have warned that high oil prices could lead to a stagflation scenario in which economic stagnation and rising prices occur together, and they discussed the possibility of further rate hikes. On the other hand, rate hikes could choke off Japan’s fragile economic recovery, increase the burden of interest expenses on the government’s massive debt, and even trigger turmoil in the government bond market. The trade-off between supporting growth, fighting inflation, and stabilizing the exchange rate leaves the Bank of Japan’s monetary policy signals unclear, unable to provide the yen with clear and strong support, and instead intensifies market wait-and-see behavior and doubts.

The rapid fading of the yen’s safe-haven attributes is the result of multiple conflicting factors converging and breaking out at once—Japan’s domestic fiscal risks, overdependence on energy, changes in market behavior, the large external interest-rate differential, and the central bank’s policy predicament. Against the backdrop of profound changes in the global economic landscape and the emergence of structural challenges unique to Japan, global investors need to reassess the yen’s asset characteristics and recognize an increasingly complex risk picture behind it.

(Source: Economic Daily)