‘Super Weak Yen Shock’ Despite Rate Hikes, Fiscal Expansion Erodes Currency Credibility

Yen Weakness Persists Despite ‘Highest Rate in 30 Years’ Increase
“Speculative Yen Sell-Off, Decisive Action Needed,” Japan Signals Possible Intervention
Fiscal Expansion Fuels Yen Selling, Highlighting Structural Economic Concerns Beyond Rates

Despite the rapidly narrowing interest rate gap between the United States and Japan, the yen’s depreciation has shown little sign of abating, marking an unusual divergence from conventional foreign-exchange dynamics. Under normal circumstances, U.S. rate cuts combined with Japanese rate hikes would compress the bilateral rate differential and lend support to the yen. This year, however, currency markets have defied that logic. Growing expectations that further rate hikes will proceed only gradually have weighed on the yen, while concerns that the Sanae Takaichi administration’s aggressive fiscal stance will widen budget deficits have reinforced expectations of additional currency weakness. Excessive fiscal expansion has emerged as a common risk undermining currency values across both reserve- and non-reserve-currency economies.

Japanese Authorities Signal Readiness for Currency Intervention

On the 22nd, Atsushi Mimura, Vice Finance Minister for International Affairs at Japan’s Ministry of Finance, warned that the yen was showing “rapid, one-sided movements” and stressed that authorities would respond appropriately to excessive volatility. The remarks amounted to verbal intervention after the Bank of Japan raised its policy rate by 25 basis points to 0.75% on the 19th, only for the yen to slide to roughly $0.0064 per unit.

Finance Minister Katayama reinforced the warning in an interview with Bloomberg the same day, characterizing the yen’s weakness as “clearly speculative movements detached from economic fundamentals.” He cautioned that the government could take “unprecedented and bold measures” to defend the currency, underscoring that Japan retains effectively unlimited discretion to intervene in markets if necessary.

Following the BOJ’s rate decision, the yen briefly weakened to about $0.00634 before recovering modestly to the low $0.0063 range after officials’ remarks. Even so, market participants increasingly expect a prolonged pause before the next rate hike, fueling forecasts that further depreciation is only a matter of time. Given that Japanese authorities previously intervened when the yen approached similar levels last year, analysts broadly expect renewed action if sharp moves reemerge. A disorderly adjustment could trigger an unwinding of yen carry trades, potentially unleashing broader turbulence across global asset markets.

Rate Hike Interpreted as a Warning, Not a Signal of Currency Strength

One key factor behind the yen’s counterintuitive response lies in the BOJ governor’s communication. Markets judged Governor Kazuo Ueda’s post-meeting remarks as insufficiently hawkish, prompting renewed selling of the yen. Rather than signaling a firm commitment to continued tightening, Ueda reiterated that policy would be adjusted in line with economic, price, and financial conditions—a stance perceived as cautious. Reuters noted that expectations for aggressive tightening faded, allowing yen carry trade positions to persist and intensify downward pressure on the currency.

The fact that policy rates have only just returned to levels seen before the collapse of Japan’s asset bubble has also tempered expectations for further hikes. Analysts argue that the BOJ is likely to observe market reactions for an extended period before moving again. Absent stronger hawkish guidance, investor expectations of prolonged policy inertia have taken hold.

Adding to the pressure, stronger global risk appetite—bolstered by softer-than-expected U.S. inflation data—has diverted capital toward U.S. equities and the dollar rather than traditional safe havens such as the yen. According to analysts at Oanda, unexpected disinflation in the U.S. amplified risk-on sentiment, accelerating capital flows away from the yen.

Markets had also largely priced in the BOJ’s rate move well in advance. Overnight index swap markets indicated near-certainty of a policy adjustment before the announcement, muting any element of surprise. As a result, investors who had positioned for yen appreciation quickly took profits, reinforcing selling pressure in a classic “buy the rumor, sell the news” dynamic.

Fiscal Expansion Raises Alarms Over Financial Sustainability

Above all, concerns over fiscal expansion have weighed most heavily on the yen. On the 16th, the Takaichi administration approved a supplementary budget totaling approximately $122 billion, the largest since the pandemic and a 31% increase from the previous year. Funding will come from higher tax revenues and additional government bond issuance. Meanwhile, Japan’s draft general budget for fiscal 2026 is projected to exceed $800 billion, setting another record.

Markets have increasingly described the policy stance as a “high-pressure economy” strategy—an attempt to force growth through aggressive spending and wage hikes to finally escape deflation. However, the approach has intensified concerns over bond supply and fiscal sustainability. Long-term Japanese government bond yields have climbed sharply, reflecting mounting risk premiums rather than optimism about growth.

Mitsubishi UFJ Financial Group observed that the recent rise in Japanese bond yields reflects anxiety over fiscal deterioration and the market’s capacity to absorb increased issuance, explaining why higher yields have failed to translate into yen strength. Credit default swap premiums on Japanese government debt have climbed to their highest levels in two years, underscoring growing concerns over sovereign risk.

The pattern mirrors developments in the United States, where persistent fiscal deficits and mounting public debt have exerted structural pressure on the dollar. Currency markets increasingly appear more sensitive to fiscal sustainability than to interest rate differentials alone. In the U.S., tolerance for a weaker dollar—amid efforts to revive manufacturing, improve trade balances, and ease real debt burdens—has become more apparent, while trade conflicts initiated under President Donald Trump have revived debate over the durability of dollar hegemony.

South Korea faces similar vulnerabilities. Despite weakness in major reserve currencies, the won has continued to depreciate, reflecting prolonged fiscal expansion and rising debt burdens. For non-reserve-currency economies in particular, sustained deficits can quickly translate into higher bond yields, rising interest costs, and a self-reinforcing erosion of currency credibility. Analysts warn that without a credible commitment to fiscal discipline, the real value of the won could continue to deteriorate over the medium to long term.