What’s going on with the weak yen?

In July 2024, the Japanese yen fell to 161 against the U.S. dollar – its weakest position since 1986. An interest rate hike from the Bank of Japan the same month saw it reverse course, but uncertainty remains around its future trajectory.

To bring some clarity to the situation, the recent Rakuten Optimism Conference welcomed Mizuho Securities vice president and market strategist Miyoko Nakashima, who headlined a panel discussion titled Factors and Impact of the Weakening Yen: What Will Happen to the Japanese Market and Businesses?

The yen operates in phases

“Since the end of the war in 1945, you can see a 25-year cycle emerge,” Nakashima explained in front of a packed business conference audience in Tokyo. “First we have the fixed rate period, when it was at 360 yen to the dollar.”

This lasted until the early 1970s. “Then we have Japan’s high-growth period – the bubble – during which the yen grew in value, with the dollar even reaching into sub-100-yen territory.”

A new phase began in the 1990s: “Japan had its ‘lost 30 years,’ during which the rate didn’t change much, staying around 100 yen.”

Now, Nakashima argues that the yen is entering a new 25-year phase, this time of devaluation.

“We had the pandemic in 2020, and then [the war in] Ukraine, and from 2022, the U.S. began raising interest rates rapidly. And that’s where this long-term trend of the weakening yen began, which is where we are now.”

Why has the yen lost value?

Nakashima offered three reasons why the yen has begun to struggle against the U.S. dollar.

“First, the disparity between the economic growth rates of Japan and the U.S.,” she highlighted. “Countries with a higher growth rate have a more attractive currency.”

This tracks with the yen’s historical trajectory. “In the 70s and 80s, Japan had stronger growth than the U.S.… but since the 1990s, the U.S. has had stronger growth.”

The second reason, Nakashima proposed, is the disparity between the two countries’ long-term interest rates.

“This difference in interest rates almost exactly matches the movement of the yen against the dollar. As the U.S. has continued to raise interest rates, Japan’s rates have barely moved. So this gap has grown wider and wider, weakening the yen.”

Further illustrating Nakashima’s point was the Bank of Japan’s July 31 decision to raise interest rates for the first time in 15 years, narrowing the gap and sparking a rally that saw the yen reach into the 140s.

Lastly, Nakashima argued, is supply and demand. “It’s a matter of whether Japan is making money.”

Since 2022, imports have outpaced exports – Japan has been buying more than it sells. Factors such as the pandemic have consumers turning more and more to foreign goods and services, meaning that yen is flowing out of Japan and being sold off for other currencies.

“Japan has now settled into a trade deficit,” Nakashima told the audience. “From a supply and demand perspective, with this as a long-term trend, there is barely any structural reason for the yen to grow stronger.”

How is it affecting businesses?

“I think there is a big difference in the effect it’s having on large and small- to medium-sized businesses. For example, large companies might be engaged in more exports,” Nakashima suggested. “They have resilience against currency fluctuations. So some might be seeing a positive effect from the weaker yen.”

This certainly isn’t the case for everyone: “For smaller companies, many of whom work with domestic demand, a weaker yen means higher costs, putting pressure on business performance.”

Nakashima was joined on the panel by Hitotsubashi University business professor Mikiharu Noma, who noted that this trend is causing some businesses to change their strategies.

“From around last year, with the weakening yen, some businesses are looking to bring manufacturing back to Japan. But even if they do that, Japan’s population is shrinking, meaning they can’t even build factories.”

With fewer and fewer workers, companies are turning to solutions like automation and AI to make up the difference.

Noma also predicts that this dynamic will spark a shift away from labor-intensive industries.

“As the population shrinks, what industries will continue to make money? I think companies with strong intangible assets will do well. Specifically, the entertainment industry. Japan’s intellectual property and contents are highly valued.”

The inflationary pressures brought on by the weak yen and other factors are also changing how businesses invest their cash. “With deflation, investments didn’t yield that much more than simply holding cash,” he reasoned. “But entering this inflationary era, we’ll see a bigger difference from those who can invest their money effectively.”

So where is the yen headed?

“One thing that might put the brakes on the weakening yen is the monetary policies of Japan and the U.S. going forward,” Nakashima predicted. “This is something that’s only emerged recently: The U.S. is headed towards interest rate cuts, while Japan is headed for rises – the exact opposite. This would reduce the rate disparity, leading to a stronger yen and weaker dollar.”

Nakashima offered three predictions for where the yen might go in the coming two years. The most likely scenario, she said, would be that the yen would continue hovering between the 135 to 160 range.

“Another rate rise is expected within the year, perhaps to 0.5%, and we are predicting another one next year, before it settles down for a while. Unlike the sudden hikes of the U.S., it will be a much milder rise.”

This mild approach to reducing the interest rate disparity wouldn’t send the yen dramatically in either direction, but see it hover around the same level it is at today.

Another scenario imagined the U.S. economy growing more than expected, weakening the yen further. On the flipside, a global risk event could send the yen in the opposite direction.

“The last scenario sees the yen growing in strength. I think the possibility of this is quite low. If the U.S. were to enter a recession, for example,” Nakashima theorized. “One perspective is that demand for yen often jumps in times of crisis like this. So a risk event could see the sell-off reversed.”

Despite these short-term predictions, Nakashima left the Optimism audience with a firm warning about the long-term factors at play.

“Here in Japan, we rely on trade. 99.7% of our crude oil is imported. There are all these factors driving down the value of the yen, so even if it goes up in the short term, I think the 25-year cycle of weakening has already begun. So it’s really important that we take measures against inflation, and to protect our assets.”