US dollar weakens but yen continues to underperform

JPY: Intervention risks are rising as Katayama warns

The US dollar weakened modestly further again yesterday and is broadly stable so far today after additional evidence of labour market weakness reinforced expectations that upcoming releases of delayed non-farm payroll reports will underline the need for further rate cuts from the Fed. Weekly data from ADP Research revealed that there were 11,250 job losses on average in the four weeks to ending 25^th October. The drop in the dollar underlined the sensitivity to private sector employment that could shape the NFP data to be released. The jobs data will be key to whether the Fed can continue to cut and is an important element of our view that the dollar can weaken notably as we approach the end of the year. The 2-year UST bond yield is down 3bps today in reaction after yesterday’s Veteran Day holiday.

The modest depreciation of the dollar has been surpassed again by the depreciation of the yen and USD/JPY continues to grind slowly higher toward the 155-level. Finance Minister Katayama has again warned on excessive yen depreciation stating that the MoF was “seeing one-sided, rapid currency moves of late” and that the government is “watching for any excessive and disorderly moves with a high sense of urgency”. The tone of these remarks are quite similar to comments made last week so in reality this doesn’t really signal an increased level of concern and hence market participants won’t give these comments to much additional attention. The acknowledgement in her comments that it is becoming clearer that there are “negative parts” to yen weakness is a shift but does not in our view signal imminent action. It will be very difficult for Tokyo to convince the markets at this stage of their intention to intervene to strengthen the yen when its rhetoric on economic policy suggests the implementation of policies that are inflationary.

This policy direction is being led by the top and PM Takaichi’s comments yesterday were telling when she stated that “it cannot be said that the Japanese economy has escaped deflation”. Japan’s headline inflation rate turned positive on a sustained basis in September 2021 and hence we have had four years of positive inflation. It is the same for core nationwide CPI as well. Excluding all food and energy (similar to core CPI in the US) inflation has been positive for three-and-a-half years. A draft of the fiscal stimulus plan has revealed that “necessary expenditures to implement required policies will be carried out without hesitation” underlining more focus on spending and less on fiscal consolidation.

The yen underperformance could well continue. Intervention will become a more credible threat at levels above 155.00 that should slow the advance while the best hope of a retracement in USD/JPY is likely a more notable decline in US yields, possibly on the back of weak NFP data.

PRONOUNCED DIVERGENCE BETWEEN BROADER USD AND USD/JPY

Source: Bloomberg, Macrobond & MUFG GMR

JPY: Record current account surplus

The yen versus the dollar is now trading at new lows not seen since February and around levels not seen since the early 1990’s and the extent of weakness continues to have a notable impact on Japan’s current account position. This is particularly the case when it comes to Japan’s investment income position. The expanding foreign asset portfolio in yen terms continues to generate increasing sized investment income surpluses due to yen depreciation and rising global yields. Fundamental Equilibrium Exchange Rate (FEER) theory points to increased support for currencies running large current account surpluses given the scope for these increasing surpluses to be converted back to the domestic currency. As these larger foreign currency surpluses are converted it drives the currency stronger and helps to reduce the size of external balances over time as the exchange rate reverts back to an equilibrium value. It certainly backs up the consensus view that the yen remains very undervalued at current levels – something the US no doubt will continue to highlight.  

The Ministry of Finance on Monday released the balance of payments statistics on Monday for September and the data revealed a record surplus was recorded in September, totalling JPY 4,483bn, nearly a threefold increase from September 2024. In the Apr-Sept period Japan also recorded a record surplus totalling JPY 17.5trn. If you annualise this the surplus in Japan now equates to 5.6% of GDP. For one of the largest economies in the world this is a huge surplus. This would also be the largest surplus in GDP terms on record.

A big driver of this increase is not in trade, but in investment income. The surplus just on FDI investment income surged to a record JPY 3,580bn in September, accounting for some 80% of the entire current account surplus. Japanese companies have continued to invest abroad and the build-up of assets will likely continue to see further record surpluses in income earned going forward, especially with the yen close to low levels not seen in over 30yrs. The FDI investment income surplus grew 5% in FY H1 versus the same period a year ago. The portfolio investment income surplus totalled JPY 7,356bn in FY H1, still substantial but in fact down 4.6% compared to the same period in 2024.

Japan’s huge foreign asset portfolio (JPY 1,650trn as of Q2 2025 or USD 10.7trn) will continue to generate significant returns that over time will likely see greater amounts being converted back to yen as JGB yields become more attractive. This clearly isn’t happening yet with real yields still in negative territory in Japan but the longer these large returns continue the more tempting converting larger amounts back to yen will become. Expectations of a stronger yen could influence that as could liquidity needs at home as rates rise and push financing costs higher.

JAPAN INVESTMENT INCOME SURPLUS SURGES TO A NEW RECORD (3MTH SUM BASIS) & ACCOUNTS FOR MOST OF CURRENT ACCOUNT SURPLUS

Source: Macrobond, Bloomberg & MUFG Research

KEY RELEASES AND EVENTS

Source: Bloomberg & Investing.com