Author Details

Michael Hayes

Michael Hayes

Executive Director, MSCI Research

Tamas Hanis

Tamas Hanis

Vice President, MSCI Research

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Looking Beyond Japan to Understand Risks to the Yen

  • The Bank of Japan’s refusal to tighten monetary conditions, despite the global inflationary environment, has brought the yen to a 24-year low against the U.S. dollar.
  • Given the limited scope of the Bank of Japan’s contemplated monetary action, the fate of the yen may depend on forces external to Japan.
  • We consider three hypothetical scenarios and their impact on a diversified portfolio: slowing inflation, accelerating inflation and global recession. The yen performs best in the global-recession scenario.

By remaining steadfast in its commitment to zero yields, the Bank of Japan may have sacrificed the ability to control its own destiny. This sentiment was reflected in a statement by Haruhiko Kuroda, the central bank’s governor: “If we want to stop the yen from weakening only by adjusting interest rates, we would need huge rate increases, and it would cause significant damage to the economy.”1 For that reason, investors exposed to Japan and the yen may need to look beyond Japan to identify the important risk factors for their portfolios.


Japan’s lower inflation led to lower-valued currency

In a world of nearly double-digit inflation, Japan remains an outlier. With inflation in July at only 2.6%, the Bank of Japan has so far been able to maintain its loose monetary policy while the rest of the developed world has tightened. This divergence has driven the yield differential between 10-year Treasurys and Japanese government bonds to 3.4%, which has led to a depreciation of the yen to a 24-year low against the U.S. dollar (as the exhibit below shows).


Widening yield differential, depreciating yen

This chart shows how the differential in yields between U.S. and Japanese 10-year government bonds has grown as U.S. rates have risen since September 2021. It also shows the yen’s slide versus the U.S. dollar over that time period.

With the yen at historic lows, it is a good time to consider: How much farther could it depreciate, and under what scenarios would it regain its lost ground? Our scenarios are informed by the view that Japanese monetary policy would be unable to stop the depreciation of the yen.2 Therefore, we consider scenarios where the yen is largely driven by factors external to Japan: the pace of inflation, monetary policy outside of Japan and the specter of a global recession.

  • Slowing inflation: Ongoing monetary-policy tightening in the U.S. and Europe reduces demand more quickly than expected, supply-chain issues improve and commodity prices come down. The U.S. and Europe slow their rate hikes, and Japan maintains its zero-yield target. The Japanese economy continues its post-COVID recovery. The yen appreciates, global inflation decreases and global equities gain.
  • Accelerating inflation: Monetary-policy tightening in the U.S. and Europe is unable to keep global inflation in check, supply-chain issues persist and commodity prices increase. The U.S. and Europe increase their rate hikes, and Japan is forced to modestly tighten its monetary policy. Stagnant wages remain the norm in Japan, and households respond to rising prices by reducing their spending, thereby hurting the local economy. The yen depreciates due to widening yield differentials. Global inflation increases, and global equities lose ground.
  • Global recession: The combination of monetary-policy tightening in the U.S. and Europe, inflation fears and global macro uncertainty leads to significantly lower economic output and a global recession. The U.S. and Europe significantly slow their rate hikes, leading to decreased long-term yields. The yen’s recent losses are wiped out due to a decrease in yield differential, and it appreciates further due to the yen’s safe-haven status. Global inflation goes down, and global equities fall significantly.


What we assume in our scenarios

   Slowing inflation Accelerating
Global recession
Inflation (BEI) 2Y -50 bps -100 bps +25 bps +200 bps -50 bps -150 bps
10Y -25 bps -50 bps +10 bps +50 bps -25 bps -25 bps
2Y flat -50 bps +50 bps +100 bps -50 bps -200 bps
10Y -10 bps -25 bps +25 bps +75 bps -25 bps -100 bps
Equity   +5% +10% -10% -10% -15% -20%
IG -5 bps -50 bps +5 bps +50 bps +15 bps +100 bps
HY - -200 bps - +200 bps - +400 bps
Oil   -10% +10% -25%
JPY vs. USD   +10% -10% +40%

The shocks are informed by analysis of historical market data, external market commentary and the MSCI Macro-Finance Model. These are not forecasts but hypothetical narratives of how the various scenarios could affect portfolios. It may take time (up to several months) for the shocks in these scenarios to materialize. Breakeven inflation (BEI), nominal yields and credit spreads in basis points (bps).


Potential implications for financial portfolios

We assessed the scenarios’ impact on multi-asset-class portfolios, applying MSCI’s predictive stress-testing framework to a hypothetical global diversified portfolio consisting of global equities, U.S. bonds and real estate.3 The impact ranged from -10% to +8% for the “Accelerating inflation” and “Slowing inflation” scenarios, respectively. The “Global recession” scenario registered a -7% return, which was more modest than the result of “Accelerating inflation,” which reflects the hedge value of Japanese assets in this scenario.


What our scenarios imply for global portfolios


Portfolio impact of the scenarios based on market data as of Sept. 2, 2022. U.S. Treasurys and Treasury inflation-protected securities and EU and Asia-Pacific sovereign bonds are represented by Markit iBoxx indexes. Equities and corporate bonds are represented by MSCI indexes. Private equity is represented by model portfolios. U.S. real estate is represented by the MSCI/PREA U.S. AFOE Quarterly Property Fund Index. Japanese real estate is represented by the MSCI Japan Annual Property Index. The composite portfolio is 50% global equities (35% public and 15% private), 10% U.S. Treasurys, 10% U.S. Treasury inflation-protected securities, 10% U.S. investment-grade bonds, 10% U.S. high-yield bonds and 10% U.S. real estate. Composite corporate-bond portfolios are 85% investment-grade bonds and 15% high-yield bonds. The Japan composite portfolio is 50% equities, 20% Japanese government bonds, 20% Japanese corporate bonds and 10% Japanese real estate. Source: S&P Global Market Intelligence, MSCI


Where could the yen go from here?

We have considered a range of hypothetical scenarios that go from 10% depreciation to 40% appreciation for the yen, which reflects the unusually wide range of possibilities for a developed-market currency. Given the divergent path Japan is on, it may take a global recession to restore the balance between Japan and the rest of the world.


The authors would like to thank Zach Tokura and Will Baker for their contributions to this post.



1Thomas, Matthew, and Fujikawa, Megumi. “Fed’s Aggressive Stance Pushes Yen to 24-Year Low Against Dollar.” Wall Street Journal, Sept. 2, 2022.

2This is because the likely range of possibilities for Japanese monetary policy is so narrow relative to that of the rest of the developed world. Some possibilities that have been discussed are expanding Japan’s zero-yield target range from +/-25 basis points to +/-50 basis points or targeting the five-year yield instead of the 10-year yield. In contrast, the Federal Reserve has already raised rates by 225 basis points, and another 75-basis-point increase is expected this month. Timiraos, Nick. “Fed on Path for Another 0.75-Point Interest-Rate Lift After Powell’s Inflation Pledge.” Wall Street Journal, Sept. 7, 2022.

3The results are generated by using model correlations to propagate shocks to the portfolios, using MSCI's BarraOne®. MSCI clients can access BarraOne® and RiskMetrics® RiskManager® files for these scenarios on the client-support site.



Further Reading

China at a Crossroads: Three Scenarios for Investors

How Eurozone Inflation and ECB Policy Could Impact Markets

Fed Policy and the Threat of Stagflation