Yen Faces Risks from Fund Flows and Trade — BNY

Geoff Yu, an analyst at BNY Mellon, noted in his latest comments that cross-border fund flows are exerting sustained downward pressure on the Japanese yen. On one hand, foreign investors are accelerating their selling of Japanese government bonds; on the other, domestic Japanese investors have increased purchases of overseas bonds and equities. This combination of "domestic capital heading abroad and foreign capital exiting" has weakened the demand base for the yen, suggesting the currency may face further depreciation. As of writing, USD/JPY is trading near 158.64682.

**Two-Way Fund Flows Undermine Yen's Foundation**

Looking at the structure of fund flows, the yen is under dual pressure. Foreign investors reducing holdings of Japanese bonds directly diminishes demand for the yen, while Japanese investors buying overseas assets need to sell yen and convert into foreign currencies for investment—the two forces combine to create sustained selling pressure on the yen. BNY Mellon's analysis indicates that the support for the yen from this fund flow pattern is systematically weakening, a trend that short-term fluctuations are unlikely to reverse.

**Deeper Challenges from Rate Differentials and Energy Imports**

Behind the yen's weakness lie deeper structural factors. Market reports indicate that Japan relies on imports for nearly all of its fuel needs, meaning rising energy prices quickly widen the trade deficit and add extra drag on the yen. Meanwhile, the Bank of Japan's long-maintained low interest rate policy has made the yen a funding currency in carry trades, where investors borrow low-yielding yen to invest in higher-yielding overseas assets—a mechanism that itself continuously generates yen selling. If the BOJ is eventually forced to adjust policy due to imported inflationary pressures, it could shake the foundation of carry trades, but until then, rate differentials remain unfavorable for the yen.

**Potential Policy Intervention and Market Risks**

Despite the yen's continued weakening, market expectations for official intervention are also heating up. Reports suggest that Japan's Ministry of Finance has indicated it may utilize the Federal Reserve's FIMA repo facility, using U.S. Treasuries as collateral to obtain dollar liquidity, thereby intervening in the FX market to support the yen while avoiding the market shock of directly selling U.S. Treasuries. However, BNY Mellon's latest analysis implies that until there is a fundamental reversal in the fund flow pattern, intervention measures may only slow the pace of depreciation rather than fully reverse the yen's weakening trajectory.