2607 the yen carrying the weight of the world s risk tolerance

The yen: carrying the weight of the world’s risk tolerance With yen weakness reflecting carry-funded risk appetite, domestic flows could signal an eventual turning point By Naomi Fink, Chief Global Strategist and Chief Economist 28 July 2026 The yen has remained undervalued by several measures despite normalisation by the Bank of Japan (BOJ), above-target inflation and narrowing US-Japan yield differentials. The role of yen-funded carry in supporting long-duration risk assets suggests that the currency may remain undervalued until risk appetite, global liquidity conditions or Japanese capital flows begin to shift.

The puzzle: why has the yen remained weak? Since March 2024, the BOJ has continued to gradually normalise policy, while Japan’s headline inflation—as well as core inflation excluding volatile and government-subsidized items—has remained above the bank’s 2% inflation target. Nominal wage growth has remained positive, with real wage growth recently following suit. Meanwhile, the yen remains cheap across a range of valuation metrics, with the currency having failed to appreciate despite reflationary signals and the narrowing US-Japan yield differential. In fact, dollar/yen appears to have become desensitised to the 10-year yield differential (see Chart 1) and has instead been moving in line with the US long-term yield (see Chart 2).

Chart 1: Decoupling of dollar/yen from the US-Japan 10-year yield spread

The bilateral spread explained the first move, but not the later yen weakness

(Percentage points) 120 0.5 100

Jan-2020 0 Apr-2020 Jul-2020 Oct-2020 Jan-2021 Apr-2021 Jul-2021 Oct-2021 Jan-2022 Apr-2022 Jul-2022 Oct-2022 Jan-2023 Apr-2023 Jul-2023 Oct-2023 Jan-2024 Apr-2024 Jul-2024 Oct-2024 Jan-2025 Apr-2025 Jul-2025 Oct-2025 Jan-2026 Apr-2026 Jul-2026

US-Japan 10-year spread (LHS) Dollar/yen (RHS)

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The yen: carrying the weight of the world’s risk tolerance

Chart 2: Dollar/yen and the US 10-year yield

US yields have been a dominant global anchor for dollar/yen (Pct) Jan-2020 0 Apr-2020 Jul-2020 Oct-2020 Jan-2021 Apr-2021 Jul-2021 Oct-2021 Jan-2022 Apr-2022 Jul-2022 Oct-2022 Jan-2023 Apr-2023 Jul-2023 Oct-2023 Jan-2024 Apr-2024 Jul-2024 Oct-2024 Jan-2025 Apr-2025 Jul-2025 Oct-2025 Jan-2026 Apr-2026 Jul-2026

This development is related to, though not the same phenomenon as, our earlier observation that yen carry (the use of low- cost yen borrowing to fund investments elsewhere) has tended to be drawn less to overseas bonds and more to a small group of high-capitalisation, long-duration risk assets, which have so far benefited most from the ongoing technology investment boom. The connection between these two trends lies in the US market. Based on the 12-month forward earnings yield for the S&P 500, US equities no longer appear to provide a sufficient risk premium to offset the rising cost of long-term funding (as proxied by the 10-year Treasury yield; see Chart 3). However, as we explain below, funding investments in yen helps to keep the risk premium more positive, even if it does not make it especially attractive.

Chart 3: Compression in US equity compensation relative to Treasuries

US equity compensation relative to Treasuries has compressed 10 8 6 (Pct) 4 2 0 Jan-2000 Oct-2000 Jul-2001 Apr-2002 Jan-2003 Oct-2003 Jul-2004 Apr-2005 Jan-2006 Oct-2006 Jul-2007 Apr-2008 Jan-2009 Oct-2009 Jul-2010 Apr-2011 Jan-2012 Oct-2012 Jul-2013 Apr-2014 Jan-2015 Oct-2015 Jul-2016 Apr-2017 Jan-2018 Oct-2018 Jul-2019 Apr-2020 Jan-2021 Oct-2021 Jul-2022 Apr-2023 Jan-2024 Oct-2024 Jul-2025 Apr-2026

US 10-year Treasury yield S&P 500 12-month forward earnings yield

(Percentage points) 6 4 2 0 -2 -4 Jan-2000 Oct-2000 Jul-2001 Apr-2002 Jan-2003 Oct-2003 Jul-2004 Apr-2005 Jan-2006 Oct-2006 Jul-2007 Apr-2008 Jan-2009 Oct-2009 Jul-2010 Apr-2011 Jan-2012 Oct-2012 Jul-2013 Apr-2014 Jan-2015 Oct-2015 Jul-2016 Apr-2017 Jan-2018 Oct-2018 Jul-2019 Apr-2020 Jan-2021 Oct-2021 Jul-2022 Apr-2023 Jan-2024 Oct-2024 Jul-2025 Apr-2026

S&P 500 forward earnings yield spread Sample average Zero