The yen's safe-haven aura rapidly fading

For more than a month, as U.S. and Israeli military strikes against Iran have stoked risk-off sentiment in global markets, the foreign exchange market has shown a completely different picture from past experience: the Japanese yen, which has traditionally served as a safe-haven currency, has not strengthened as it did in previous crises. The yen has been sliding against the U.S. dollar, even breaking through the key psychological level of 160 yen per $1 and hitting a two-year low. Once seen as a financial “safe harbor,” the yen’s luster is rapidly fading under the dual pressure of intensifying international geopolitical crises and Japan’s domestic economic structural contradictions.

This shift is first driven by the immense uncertainty created by Japan’s overzealous domestic macroeconomic policy. The fiscal expansion measures introduced by the Takaji Saito administration at the end of 2025 push the 2026 fiscal-year budget to a high of 122.3 trillion yen, with nearly one-quarter relying on newly issued government bonds. Japan’s total government debt to gross domestic product (GDP) ratio has already exceeded 260%. This kind of fiscal model—lacking clear sources of funding and effectively “paying debt with more debt”—has severely shaken international markets’ confidence in Japan’s fiscal sustainability and the yen’s value stability, creating the biggest crack in the yen’s credit foundation.

The deeper shock comes from Japan’s energy weak spot. As a resource-poor island nation, Japan relies on imports for more than 90% of its crude oil, with the vast majority transported through the Middle East. Disruptions to passage through the Strait of Hormuz have sent international oil prices soaring. For Japan, this is no different from enduring an imported inflation “storm.” Higher oil prices worsen Japan’s terms of trade, meaning it needs to pay more yen to exchange for dollars to buy energy, which in turn exacerbates the trade deficit and puts sustained downward pressure on the yen exchange rate. Research from the Nomura Research Institute suggests that this crisis could lower Japan’s real GDP by 0.65% while raising prices by 1.14%. When local conflicts directly damage Japan’s economic fundamentals, capital will not flow into the yen for refuge; instead, the yen may accelerate its flight due to the economy’s vulnerability.

Market preferences that support a stronger yen are changing. In the past, when global risk rose, Japan’s large overseas corporations and investors would bring profits and assets back home on a massive scale, creating strong demand for the yen. Some analysts point out that after the pandemic, Japanese companies have been more inclined to keep funds overseas for reinvestment or allocation rather than to repatriate them during crises. This shift has caused the yen to lose a substantial portion of its endogenous support. When external shocks arrive, without the hedge of domestic fund repatriation, the yen becomes more susceptible to one-way selling pressure.

The massive interest-rate differential between the U.S. and Japan creates persistent depreciation pressure on the yen. In recent years, U.S. interest rates staying at high levels has fueled a large volume of carry trades: investors borrow low-cost yen, convert them into U.S. dollars or other high-yield currency assets, and profit from 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 still wide gap of as much as about 3% compared with the U.S. federal funds rate. When global conditions are turbulent, closing out these trades may temporarily support the yen, but in most cases, the very existence of the spread acts like a magnet—continuously attracting capital outflow from Japan—creating a long-term, fundamental suppression of the yen.

Amid a complex situation, the Bank of Japan faces a dilemma in monetary policy, 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 Bank of Japan’s March meeting show that some members have already warned that high oil prices may lead to a stagflation scenario in which economic stagnation and rising prices coexist, and they discussed the possibility of further rate hikes. On the other hand, rate hikes could choke off Japan’s fragile economic recovery, worsen the government’s burden of interest on 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, preventing them from providing clear and strong support for the yen—and instead intensifying market wait-and-see sentiment and doubts.

The rapid fading of the yen’s safe-haven attribute is the result of multiple conflicting issues concentrating and breaking out at once: Japan’s domestic fiscal risks, overreliance on energy, changes in market behavior, the huge 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 Japan’s own structural challenges, global investors need to reassess the yen’s asset characteristics and recognize that the risk profile behind it is becoming increasingly complex.

（Source: Economic Daily）