TOKYO – As Donald Trump makes recessions great again and the dollar a has-been, Japan’s yen is developing a safe-haven halo faster than Tokyo’s policymakers would like.
The extent to which the US president’s trade war is slamming confidence in dollar assets can be seen in the Japanese currency’s roughly 10% rally so far this year, trading today at around 144. The yen’s rally has also forced the Bank of Japan to abandon long-held plans to raise rates again today (May 1).
BOJ Governor Kazuo Ueda’s experience with the first 100 days of the Trump 2.0 presidency has been as chaotic as anyone’s. Back in January, Ueda was full-speed ahead with his two-year quest to end Japan’s deflation-era policy matrix.
That month, Ueda’s team hiked benchmark rates to a 17-year high of 0.5%. A month ago, most economists thought the BOJ would hike rates to 0.75% this week, kicking efforts to exit quantitative easing into higher gear.
Then came Trump’s tariffs, which have economists downgrading Japan’s prospects in real time. Case in point: factory output across Japan fell 1.1% in March from February as US tariffs slammed manufacturers. The sector is now performing below where it was in 2021 at the height of Covid-19.
It’s a reminder, says Moody’s Analytics economist Stefan Angrick, that Japanese “manufacturing has gone from bad to worse since the pandemic, grappling with supply-chain disruptions, domestic production hiccups and increased foreign competition.”
Yet, Angrick says, “things will only get more difficult from here” in light of Trump’s 25% tax on autos and 24% tariff on Japan. “Although pauses and partial exemptions have provided some temporary relief, Washington’s trade threats have significantly complicated the outlook, depressing business and consumer confidence,” he says. This, Angrick notes, means “Japan can’t bank on domestic demand to offset the impact of weaker exports.”
Hence, the BOJ’s reluctance to continue hiking rates. That’s despite Ueda’s team downgrading its gross domestic product (GDP) forecast by more than half – to 0.5% from the 1.1% figure it set in January. In its why-we-stood-pat statement on May 1, the BOJ noted that “trade and other policies” hitting overseas growth dominated its decision.
Economists are doing their best to put a brave face on the BOJ’s failure to act, even with Japanese inflation well above 3%.
“If anything,” says Krishna Bhimavarapu at State Street Global Advisors, “we see a small tailwind due to two reasons: the first reason is a stronger yen may lower Japan’s inflation, which is still the most intense among advanced economies, and the second reason is as the BOJ gains confidence that the wage-price cycle may remain intact even as the yen strengthens. We see the BOJ hiking once this year, but more importantly, staying the course next year if the global economy soft-lands like we expect.”
The word “if” is doing lots of work in such analyses. For the BOJ, so are concerns that the yen’s rally might imperil its best-laid plans for the rest of 2025. Given the policy chaos in Washington and fresh signs the US may be headed for recession, prospects for the BOJ’s rate “normalization” campaign are dimming by the month.
News that US “growth has simply vanished,” says Chris Rupkey, chief economist at financial research firm Fwdbonds, complicates things for the Federal Reserve.
Not everyone thinks the 0.3% drop in annualized growth in the year’s first three months means the US is suddenly veering into downturn territory. “While a decline during an expansion is unusual, it’s not unheard of, and the economy isn’t in a recession,” says Ryan Sweet at Oxford Economics.
Yet the first quarter of negative GDP growth since early 2022 is sure to have Trump ratcheting up pressure on Fed Chair Jerome Powell to ease rates. Already, Trump’s assault on the Fed’s independence has unnerved bond investors, pushing yields on 10-year debt up to 4.2%.
This creates a fresh dilemma for Ueda should the yen’s sudden place in the safe-haven spotlight persist and broaden. In recent decades, it was the yen’s weakness that captivated investors via the so-called “yen-carry trade.”
Twenty-six years of near-zero rates turned Japan into the world’s top creditor nation. Investors everywhere made it standard practice to borrow cheaply in yen to bet on higher-yielding assets from New York to Sao Paulo to Seoul.
That’s why the slightest plunge or rally in the yen can send shockwaves through asset markets around the world. Traders in Tokyo often joke that the yen-carry trade is the financial equivalent of the shark from “Jaws.”
Several times during Steven Spielberg’s 1975 film, the killer shark appeared to lose interest in its victims. This lulled them into a false sense of comfort, only for the shark to reappear suddenly and wreak havoc.
The carry trade hasn’t gone as far underwater as many investors believe. No one can say whether Team Ueda might make good on its hawkish rhetoric earlier this year. But now that Trump’s tariffs are hitting Japan, it’s highly likely that the BOJ will become even more reluctant to tighten for fear of the impact of a surging yen on Asia’s No 2 economy.
Count David Roche, a strategist at Quantum Strategy, among those who think the yen is becoming the currency of choice for many investors seeking cover from Trump’s unpredictable policies.
“You want to keep out of the euro and own the yen, which is now the new safe haven as the US is getting to look very dangerous and US exceptionalism will suffer from the costs of Trump’s commercial tariffs,” Roche tells Fortune magazine.
Nada Choueiri, deputy director of the International Monetary Fund’s Asia-Pacific department, says the yen “remains a safe-haven currency given the strength of the economy, as well as the predictability and stability of the economy.”
Choueiri added that Tokyo “authorities are committed to a flexible exchange-rate regime. It serves the country well. It helps absorb shocks. We support their commitment to this regime, and it helps the economy to adjust.”
Yet Trump’s desire for a weaker dollar and stronger yen could push the limits of Tokyo’s tolerance for a stronger exchange rate. One problem is that China isn’t budging on the yuan.
The more the yen rises while the yuan stands still, the more Japan risks losing competitiveness in its own backyard. Also, with national elections approaching in July, it’s impossible for Tokyo to ignore the hyper-fraught trade environment that lies ahead.
Already, China’s deflation and overcapacity problems are upsetting the political discourse in Tokyo. Any narrative around Japan Inc being on the losing side of trade currents in Asia could complicate life for both Ueda and Prime Minister Shigeru Ishiba’s Liberal Democratic Party.
Recently, Japanese Finance Minister Katsunobu Kato stressed that he and US Treasury Secretary Scott Bessent “did not touch upon exchange-rate targets” while discussing a US-Japan trade deal.
Trump, though, clearly wants a stronger yen. Yet the currency extending recent gains may unnerve officials worried about Japan’s growth outlook.
Coming on top of Trump’s tariffs – and the ever-present risk of more to come – the yen appreciating 15% or 20% this year could devastate Japan’s growth prospects.
Citigroup analysts, for example, warn that targeting a stronger yen through a coordinated devaluation effort, a “Mar-a-Lago Accord”, perhaps, may hurt Japan’s interests, especially in the fragile global financial environment Ueda’s economy is struggling to navigate.
Worries about Trump trying to bully Group of Seven members into engineering a weaker dollar have world markets in a constant state of anxiety.
“Ultimately, the administration faces the challenge of reconciling its policy preference for a weaker dollar with the reality of entrenched global demand for US assets,” says economist Marcello Estevao at the Institute of International Finance.
“Currency realignment depends not on tactical market interventions but on credible fiscal frameworks and sound economic governance. The path forward lies in navigating these structural forces with realism, balancing policy goals against the fundamental constraints imposed by global capital markets,” Estevao says.
BMI Research, a Fitch Solutions company, argues that “on the yen, we maintain our forecast for it to strengthen to JPY137/USD by the end of this year, but we now see higher risks of a stronger yen with increasing demand for safe assets and more-than-expected cuts by the Federal Reserve narrowing the interest rate differential in the yen’s favor.”
Yet there’s little reason to think Japan Inc is ready to absorb a sharply higher exchange rate. The hit to corporate profits could give global funds pouring back into Japan in recent years some serious buyer’s remorse.
For a quarter century now, but especially the last 12 years, a weaker yen has been the glue holding Japan’s uncompetitive economy together. Ultraloose BOJ policies and a falling exchange rate enabled Tokyo to slow-walk steps to reduce bureaucracy, reinvigorate innovation, boost productivity, internationalize labor markets and empower women.
As the liquidity tide leaves the dollar and the yen rises, though, Japan will be hard-pressed to keep growth in positive territory at all.
Follow William Pesek on X at @WilliamPesek