TOKYO – As the yen staggers back to 1986 levels at around 162 to the dollar, the financial Frankenstein Japan began stitching together that same year is returning to upend the economy in 2026. The timing couldn’t be worse: traders are now asking whether 170 or even 200 is next.
The experiments of 40 years ago are coming back to haunt Bank of Japan Governor Kazuo Ueda in spectacular fashion. Attention keeps drifting to Finance Minister Satsuki Katayama, but the real work of halting the yen’s slide and papering over Tokyo’s titanically large public debt falls to the central bank.
Odds are the currency’s 3.8% drop this year will accelerate as traders test Tokyo’s ability to contain the creature it built. As such, the yen “no longer trades like a G10 currency,” says Jordan Rochester, a strategist at Mizuho Bank.
The modern yen’s DNA formed in the mid-1980s, after the 1985 Plaza Accord sent it skyrocketing and rocked Japan Inc. As the economy fell into the red the following year, the BOJ eased aggressively. That largesse inflated an asset bubble that burst around 1990, birthing Japan’s lost decade.
With growth flatlining, officials set out to reanimate Japan Inc. — layering fiscal and monetary treatments atop one another, patch after patch. Zero rates in 1999 created the conditions. The QE pioneered by the BOJ in 2001 amplified them. Years of political inertia locked the creature in place. It mutated into something policymakers can no longer fully control.
Unwilling to admit what it had built, the BOJ went bigger in 2013. This was the real Frankenstein-assembly moment: under then-Governor Haruhiko Kuroda, the BOJ unleashed “quantitative and qualitative easing.” This QQE is the monetary equivalent of the lightning bolt that jolted the creature fully to life.
Now it’s doing things Tokyo would rather it didn’t — starting with terrifying markets everywhere. Thanks to the yen-carry trade, in which investors borrow cheaply in Japan to fund bets everywhere else, sharp yen moves ripple through global bonds and stocks far out of proportion to Japan’s own size.
How Tokyo stops the slide isn’t clear. Between April and May, Japan spent more than 11.7 trillion yen ($72.8 billion) in foreign reserves to prop up the currency. It’s still sliding. One possible remedy: the US Treasury joining the Ministry of Finance in a coordinated intervention. Treasury Secretary Scott Bessent has urged the BOJ to accelerate rate hikes and left the door open to joint operations.
But Tokyo should look inward for why it’s losing control of the exchange rate. Since taking power in October, Prime Minister Sanae Takaichi has sketched out a predictable, potentially costly growth plan. Like her mentor Shinzo Abe, she wants the BOJ to keep pumping monetary lightning into the economy while she reopens the fiscal floodgates — consumption tax cuts included.
Bond traders aren’t buying it. In May, JGB yields rose to 2.8%, their highest in 29 years. That’s partly the result of Tokyo carrying the world’s largest debt load — between 240% and 260% of GDP — atop a fast-shrinking population.
It’s partly the product of stagflation: this year’s 0.5% growth rate is clashing with a 2.8% reading on the BOJ’s own inflation gauge. The bottom line, says Gavekal Research economist Udith Sikand: markets perceive the BOJ as behind the curve on inflation.
But the yen’s decline also reflects a loss of faith. After three decades of Tokyo engineering a weak currency and four decades of the BOJ manipulating yields, many global funds now view Japan less as a long-term investment case than as a playground for short-term currency plays.
“To avoid a debt crisis, the Bank of Japan caps bond yields, which keeps the government’s interest burden manageable,” says Robin Brooks, economist at the Brookings Institution. “But this means that risk premia aren’t reflected in bond yields. Interest rates are too low versus the risk of crisis in the eyes of markets.”
That, Brooks adds, “puts depreciation pressure on the yen, since investors have little incentive to stay in Japan. The government periodically intervenes in foreign exchange markets to stop the yen from falling too rapidly, but this approach is doomed to fail because it treats the symptom — yen depreciation — and not the disease — too much debt.”
In fact, Brooks adds, “it’s my view that FX intervention is deeply counterproductive because it creates the illusion that nothing’s wrong when, actually, there’s a very serious crisis brewing.”
Takaichi is tempting fate by pushing the same old experiments with little fresh thinking. Meanwhile, the BOJ appears to be giving her Liberal Democratic Party much of what it wants by throttling back its own normalization.
Ueda’s BOJ did hike short-term rates last month to a 31-year high of 1%. But it also eased up on quantitative tightening, holding monthly bond purchases steady at roughly 2 trillion yen ($12.5 billion) rather than trimming them further.
It’s a reminder that even Japan’s modest growth still runs on modern history’s most assertive economic and corporate welfare regime.
After the 2008 Lehman shock, central banks everywhere copied Japan’s QE playbook. But the Fed, the European Central Bank, the Reserve Bank of Australia and others eventually found their way out. Japan hasn’t.
Regardless of its benchmark rate, the BOJ still holds most of Japan’s outstanding government debt on its own balance sheet and remains the largest owner of Tokyo stocks via ETFs.
The BOJ’s balance sheet, which in 2018 exceeded the size of Japan’s US$4.2 trillion economy, still needs to be unwound. Yet 27 years on, Tokyo has yet to pull out the monetary intravenous tubes. And currency traders know it.
That’s part of why it struck many as odd that the yen didn’t rally after the US and Israel struck Iran. In years past, the currency would have surged on any “risk-on” shift in markets. Now, cynicism over Tokyo’s policies has merged with a market perception that the economy isn’t as robust as officials claim.
“On the downside, uncertainty surrounding the Middle East situation remains elevated, while weak business sentiment and capex plans among small non-manufacturers, typically more sensitive to the business cycle, are a concern,” says Takeshi Yamaguchi, chief Japan economist at Morgan Stanley MUFG.
“In addition, both firms and households are likely to have brought forward demand due to concerns over future price increases and supply disruptions. As front-loaded demand is typically followed by a payback, part of the strength in production and durable goods consumption should be discounted,” Yamaguchi says.
Japan’s weak-yen problem could also shake the US bond market in the months ahead — namely if Tokyo, the largest foreign holder of US Treasuries, starts selling dollars aggressively.
“Japan’s currency weakness is widely viewed as a domestic issue, which I believe is a mistake,” says Nigel Green, CEO of advisory firm deVere Group. “Japan remains one of the largest foreign holders of US government debt. If intervention efforts become larger, longer, and more frequent, the implications go well beyond the foreign exchange market.”
With more than $1 trillion in Treasury holdings, Green notes, Japan ranks among Washington’s biggest overseas creditors. If Japanese authorities are compelled to keep propping up the yen over a prolonged period, he warns, “global investors could suddenly find themselves confronting an entirely different risk” — the world’s largest foreign holder of US Treasuries becoming a more significant seller.
Not everyone is convinced the dollar is vulnerable, despite legislative chaos in Washington and a national debt approaching $40 trillion. “Without a meaningful shift in US interest rate expectations, global risk appetite or coordinated international intervention, selling dollars against the yen remains a difficult proposition,” says Chris Weston, head of research at Pepperstone Group.
There’s also plenty of bullishness toward Japan, a decade after the Abe government began prodding companies to strengthen corporate governance.
“Japan is finally seeing that its companies are getting pricing power because of the exit from deflation,” Jimmy Chang, chief investment officer at Rockefeller Global Family Office, tells Dow Jones. “We still like the Japanese equity market relative to other international markets.”
Yet Japan’s Frankenstein problem could rear its head in the bond market at any moment. Between inflation stoked by the Iran war and Takaichi’s ambitious fiscal plans, the “bond vigilantes” are in a whirl.
“Higher inflation and prospects of additional fiscal support are putting pressure on JGB yields,” notes Deborah Tan, an analyst at Moody’s Ratings.
In the months before she took office 253 days ago, Takaichi rattled debt markets with talk of fiscal pump-priming — this after her predecessor, Shigeru Ishiba, warned in May 2025 that Tokyo’s deteriorating finances were “worse than Greece.” His point: with an out-of-control debt-to-GDP ratio and a fast-aging workforce, a tax cut looks reckless.
There are unique reasons the often-predicted JGB crash never seems to arrive. For one, 90% of JGBs are held domestically, sharply reducing the risk of large-scale capital flight.
Banks, insurers, pension funds, endowments, the postal system and the growing ranks of retirees would all suffer painful losses in a selloff — so the collective incentive is to hold rather than sell.
Even Japan’s inward‑facing debt market can’t seal itself off from global tremors. That’s why Tokyo is suddenly whispering about a potential “Liz Truss moment.”
In 2022, then‑UK Prime Minister Truss rattled Britain’s gilt market by trying to slip an unfunded tax cut past bond investors — a fiasco Takaichi’s party should keep front of mind as it toys with fiscal loosening.
Meanwhile, the yen is sliding toward 170 per dollar, with 200 no longer unthinkable. It’s territory last visited in the downcast 1980s. Exchange rates have a way of cutting through political spin; denial doesn’t stop the math. Tokyo is learning that lesson now in real time.
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