USD/JPY has broken its historical link to US–Japan yield spreads, with correlations turning negative as Japan-specific risks dominate. Fiscal concerns under the new administration may keep the yen weak even if rate differentials continue to compress, MUFG's FX analysts Lee Hardman and Abdul-Ahad Lockhart report.

USD/JPY fair balue divergence widens

"The recent relationship between USD/JPY and US-JP yield spreads confirms a structural shift in USD/JPY dynamics. Historically, the pair has closely tracked short-term US-JP rate differentials, making the 2-year spread a core input in our short-term fair value model alongside implied volatility, risk reversals, and other macro features."

"However, since October, our regression models have shown a persistent mis-valuation between spot and the fair value. This divergence coincides with a sharp drop in correlation between USD/JPY returns and US-JP yield spreads: prior to October 2025, the 12-week rolling correlation with the 10-year spread averaged +0.43, peaking at 0.91 in February, whereas post-October 2025 the average correlation collapsed to -0.07 with eight consecutive negative weeks through to the present."

"We interpret this as USD/JPY price action reflecting Japan-centric risk factors rather than US rate dynamics. This shift is driven by fiscal uncertainty triggered by Sanae Takaichi becoming prime minister and the bigger extra budget. Consequently, the upcoming policy decisions from the BoJ and Fed may exert less directional pull on USD/JPY than in prior regimes. If fiscal concerns persist the yen could remain weak even as yield spreads continue to narrow."