Japanese exchange rate storm brewing: Under the strong US dollar, how much further is there after breaking through the 158 level?

USD/JPY recently surged past the 158 mark, with a quote of 158.20 as of January 12, marking a new high since January 2025. Behind what seems like a routine exchange rate fluctuation, multiple factors are colliding—rising political risks, divergence in central bank policies, intertwined economic data—investors face critical judgments about the future direction of the Japanese yen.

Political Variables Catalyze the Dollar’s Rise

Japanese Prime Minister Fumio Kishida may announce the dissolution of the House of Representatives during the parliamentary session on the 23rd, with the House election likely to be held on February 8 or 15. This political uncertainty directly impacts market expectations. Meanwhile, U.S. non-farm employment data show mixed results: December added only 50,000 jobs, below expectations, but the unemployment rate unexpectedly fell to 4.4%, creating a mixed picture of hot and cold.

Against this backdrop, market expectations for the Federal Reserve’s policy path have adjusted—probability of rate cuts in January is nearly zero, with the first rate cut window pushed back to June. This shift in perception strongly supports the dollar, exerting direct pressure on the Japanese exchange rate.

The Bank of Japan Lagging, Fiscal Policy Accelerating

Asymmetry in economic policies becomes another core variable. The Kishida government actively promotes “responsible proactive fiscal policy,” while the Bank of Japan remains relatively conservative. Daisaku Ueno, Chief FX Strategist at Mitsubishi UFJ Morgan Stanley Securities, pointed out: “When the central bank tightens policy, the government is releasing fiscal stimulus, making inflationary pressures likely to remain high.”

More notably, Japan’s real wages have fallen into negative growth for 11 consecutive months. Although nominal wages have increased, they have consistently lagged behind price rises. This reflects structural contradictions within the Japanese economy and indirectly weakens the political space for further rate hikes by the central bank.

Divergence in Exchange Rate Outlooks

Market institutions’ views on the future of the Japanese yen are clearly divided:

Bearish camp believes pressure is still mounting. Mitsubishi UFJ Morgan Stanley Securities forecasts the yen will further depreciate to 160 by the end of 2026, while Fukuoka Financial Group predicts a more aggressive move possibly reaching around 165. The logic supporting this view is the continuation of a strong dollar cycle and the persistent widening of the U.S.-Japan interest rate differential.

Bullish camp points to political change as a turning point. Nomura Securities predicts the yen will appreciate to 140 by the end of 2026 (i.e., USD/JPY falling to 140). The core argument is that Trump is expected to nominate a new Fed Chair as early as January 2026, and during the transition period, Fed policy may face intermittent rate cuts.

Mitsui Sumitomo DS Asset Management’s Chief Macro Strategist, Masayuki Yoshikawa, believes the key variable lies in expectations: “If market concerns about the Bank of Japan’s delayed rate hikes gradually ease and prices stabilize, narrowing the U.S.-Japan interest rate differential could push the yen higher.”

How Should Investors Respond?

In the short term, the Japanese yen will still be dominated by political developments and Fed expectations. But in the medium term, whether the Bank of Japan ultimately raises rates, by how much, and the actual implementation of government fiscal policies will determine whether the yen continues to depreciate to 160 or even 165, or reverses and approaches 140. The current 158 level is just a transitional point; the true direction remains in the hands of policymakers.