Asian currency outlook: Is the yen set to strengthen?

For years, Hong Kong travelers have enjoyed curiously affordable holidays across Japan. How long can this last? 

With the Bank of Japan widely expected to raise interest rates at its next policy meeting on September 18 and following the extraordinary joint intervention by Japanese and US monetary authorities to support the Japanese currency, these holidaymakers as well as the broader market are looking for clarity as to whether the yen is finally on a firm strengthening path.

We have been here before. Brief cycles of appreciation have proven fleeting for nearly 15 years, with the yen on a seemingly endless weakening trajectory. Even with the recent rally, JPY remains near its lowest level against the US dollar for over three decades. 

What accounts for this ongoing structural weakness? Regardless of the country’s foundational economics, the direction of yen has primarily been driven by the “carry trade” dynamic, which started after the asset bubble burst in the early 1990s and after interest rates in the country collapsed. 

For most of this century, investors have viewed currencies broadly through this remarkably simple lens: buy those with the highest yields and sell the ones with the lowest. The carry trade thus became a defining feature of modern finance. Investors borrowed Japanese yen at near-zero interest rates and deployed the money into higher-yielding assets around the world.

The trade worked because inflation remained relatively subdued across most major economies, central banks retained credibility, and exchange rates largely followed interest rate differentials.

The result has been a persistently weak yen, despite a few years of relative strength following the global financial crisis in 2008, and enormous capital flows out of Japan and into higher-yielding currencies and risk assets.

With the BoJ having exited its zero-rate regime in 2024 and with another rate rise highly likely, this dynamic may be changing. The currency has remained weak since then, but today investors are broadening their attention beyond interest rates. They are looking more at inflation, fiscal sustainability and purchasing power.

That distinction matters because the traditional carry-trade framework assumes that inflation is under control. If inflation remains structurally higher than investors expect that currency's yield becomes less attractive. What matters instead is whether that currency is likely to preserve its value over time.

Viewed through that lens, Japan looks very different. Japan runs a substantial current-account surplus, maintains comparatively restrained wage growth and, despite recent concerns over government debt, still exhibits fewer inflationary pressures than many Western economies. The United States, by contrast, continues to run large fiscal and trade deficits, faces persistent labor-market tightness and is struggling to bring inflation convincingly back to its stated target.

Currency markets are still pricing in a consensus that US inflation will ultimately return to 2 per cent. However it’s very possible that US inflation settles closer to 3 per cent; in such an environment, investors may become less willing to hold US dollars simply because US interest rates are higher.

Instead, they may begin favoring currencies backed by stronger external balances and lower inflation risks. The implications for global currencies could be profound.

This dynamic can help explain why the Chinese yuan has been on a remarkably steady appreciation path since the start of 2025, or why the Swiss Franc can maintain its leading position against the US dollar despite 0% interest rates. A credible handle on inflation by a trustworthy monetary authority is at the core. 

Japan does indeed face deep economic challenges including depopulation, deteriorating public finances, low productivity growth and an increasingly competitive China taking market share in its exports. But currencies are valued relative to other currencies – if the US inflation outlook becomes further unanchored, the yen is likely to strengthen further. 

What about other highly traded Asian currencies? The Chinese yuan also appears supported by similar fundamentals to Japan, including an expanding trade surplus and low inflation, although policy considerations are likely to remain a key driver of the exchange rate.

Other more freely convertible currencies such as the Korean won and Taiwan dollar may be among the main beneficiaries in this new environment. Both economies are central to the global semiconductor and artificial intelligence supply chain and already enjoy stronger fundamental support than many investors acknowledge. Their central banks also pass the essential test I’ve outlined: strong credibility with global investors to maintain inflation stability. A world of structurally weaker US dollar dominance and reduced carry-trade activity could reinforce capital inflows into these markets.

The broader point is that Asian currencies may be entering a new phase. For much of the past decade, the principal debate revolved around China and whether the renminbi was overvalued or undervalued. Today, a more important question is whether investors continue to trust the inflation outlook embedded in US markets.

If they do, the US dollar remains dominant, and the carry trade survives. If they do not, then the strengthening of Asian currencies could become one of the most important investment themes of the next several years. That would represent much more than a Japanese story.


Investment risks:

The value of investments and any income will fluctuate (this may partly be the result of exchange rate fluctuations) and investors may not get back the full amount invested.