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The Yen: More Than a Rate Story
24/7/2026
The real yen is trading close to historic lows. The reason lies less in interest-rate differentials than in three decades of persistent capital outflows.
USD/JPY has recently climbed back above 162, leaving the yen as weak as it has been in roughly 40 years. At the same time, the Japanese government has urged pension funds, insurers and other institutional investors to allocate more capital to domestic assets. The debate is no coincidence. In our view, the yen’s extraordinary weakness is about far more than current interest-rate differentials.
A look at the real effective exchange rate highlights the scale of the decline. In addition to exchange rates, this measure takes account of inflation differentials relative to a country’s most important trading partners. Since peaking in the mid-1990s, the corresponding Bank for International Settlements index has fallen from nearly 200 to around 66. In real terms, the yen has therefore lost roughly two-thirds of its value.
This development is often explained primarily by monetary policy. To be sure, the Bank of Japan was a pioneer in adopting zero interest rates, quantitative easing, negative rates and later yield curve control. As a result, the yen became the preferred funding currency for international investors. The sharp rise in interest rates across the U.S. and Europe since the pandemic only reinforced that trend.
Yet the real constant over the past three decades has been capital flows. After the collapse of Japan’s asset-price bubble in the early 1990s, many companies shifted production and investment overseas. At the same time, weak economic growth, low inflation and limited domestic return opportunities encouraged insurers, pension funds and other investors to place an ever-larger share of their assets abroad.
As a consequence, Japan evolved into one of the world’s largest exporters of capital. Today, the country owns a vast stock of foreign assets and generates a significant share of its income from overseas investments. Much of that income, however, is reinvested abroad rather than converted back into yen. In addition, Japanese households have increasingly expanded their investments outside the country.
“The key question for the yen is whether income generated abroad ultimately flows back to Japan or remains invested overseas. This is precisely where Japan’s economic model has undergone a fundamental shift over the past several decades,” says Xueming Song, FX Strategist at DWS.
That makes the latest signals from Tokyo worth watching. By encouraging pension funds and insurers to invest more heavily at home, the government is addressing not only the symptoms of a weak currency but also one of its potential causes: persistent structural capital outflows.
This week’s Chart of the Week is therefore not only about a currency. It illustrates how an economy’s capital has increasingly been put to work beyond its own borders. The key question for the years ahead is not simply where interest rates are heading. More important will be whether Japan can once again become attractive enough to retain a larger share of its capital at home. That, in our view, would make a more durable recovery in the real yen more plausible.
Sources: Bloomberg Finance L.P., DWS Investment GmbH as of 7/20/26
* REER (Real Effective Exchange Rate): Inflation-adjusted, trade-weighted exchange rate against a country's major trading partners.
This information is subject to change at any time, based upon economic, market and other considerations and should not be construed as a recommendation. Past performance is not indicative of future returns. Forecasts are based on assumptions, estimates, opinions and hypothetical models that may prove to be incorrect. Alternative investments may be speculative and involve significant risks including illiquidity, heightened potential for loss and lack of transparency. Alternatives are not suitable for all clients.