Investors have more to worry about than yen bears on the hunt

Why are global investors so bearish on the yen? There are good reasons Japan’s currency should be gaining in value. Last month, the Bank of Japan (BOJ) raised interest rates to a 31-year high of 1 per cent and signalled it would continue increasing borrowing costs. Bond markets are currently pricing in a nearly 90 per cent probability of another increase by December.

Nominal wages in Japan have risen by more than 3 per cent for four straight months, the longest streak since 1992. Moreover, the findings of the BOJ’s quarterly Tankan business survey on July 1 showed confidence among large manufacturing firms rose to its highest level since 2018, allaying fears that the global energy shock would undermine sentiment.

Another reason the yen should be strengthening is the dramatic rise in Japanese government bond yields. The 10-year yield, which was barely above 1 per cent as recently as the end of 2024, has shot up to 2.8 per cent, its highest level since 1996. This has narrowed the yield gap between benchmark Japanese and US bonds to 1.7 percentage points, down from about four in October 2023.

Even so, on June 30 the yen fell to its weakest level against the US dollar since December 1986. Hedge funds have ramped up their bets against Japan’s currency to the highest level since 2007, according to Commodity Futures Trading Commission data.

The yen’s persistent decline is attributable to several factors. One of the most important ones is the breakdown in the correlation between movements in bond yields and the currency. Worryingly, as yields rose steeply in the last 18 months, the yen continued to fall, a phenomenon typically associated with vulnerable emerging markets.