Mizuho says yen's drop to historic low overturns market assumptions; US-Japan interest rate differential model fails

Source: Global Market Broadcast

Mizuho Bank stated that the yen's drop to historic lows is forcing investors to rethink a long-standing strategy commonly used to gauge yen movements.

For years, strategists have relied on the interest rate gap between Japan and the United States as a key basis for forecasting USD/JPY levels, since an increase in Japanese yields, compared to U.S. Treasury yields, has typically been seen as supportive of the yen. However, in recent years this relationship has reversed: the yen has continued to weaken even as domestic yields have climbed, a trend also observed in certain other G10 currency markets.

Jordan Rochester, Head of EMEA Fixed Income, Commodities, and Currencies (FICC) Strategy at Mizuho, pointed out in a report that if the reversed correlation between the yen and interest rates serves as an indicator, the yen is no longer trading like a G10 currency. He noted that this shift reflects changes in risk-averse behavior after market volatility triggered by U.S. President Trump's “Liberation Day” tariffs, alongside increased participation by overseas investors in the Japanese government bond market.

This week, the yen fell to its weakest point since 1986, breaking past the 162 yen per dollar threshold on Tuesday. Japanese authorities have stayed out of the forex market over the past month; previously, from April 28 to May 27, Japan spent a record 11.73 trillion yen ($72.1 billion) as USD/JPY fell below 160 for the first time.

Strategists are now increasingly viewing 163 or even higher levels as the next benchmarks, believing the Ministry of Finance may tolerate a weaker yen than during the 2024 intervention period.