Why the Japanese Yen and Equities Are Poised for a Strategic Re-rating in 2025–2026

The Japanese yen (JPY) has long been a currency of paradoxes: a safe-haven asset in times of crisis yet a neglected play in bull markets. In 2025, however, the yen is emerging from the shadows of decades of ultra-loose monetary policy, driven by the Bank of Japan's (BoJ) cautious normalization, a structural current account surplus, and undervaluation metrics that suggest a compelling case for strategic currency positioning. For investors, the interplay of these factors—coupled with sector-specific opportunities in Japanese equities—presents a rare confluence of macroeconomic tailwinds.

The BoJ's Cautious Tightening: A New Era of Policy Normalization

The BoJ's decision to raise its policy rate to 0.5% in January 2025 marked a historic pivot after years of near-zero interest rates. This 17-year high reflects the central bank's acknowledgment of Japan's inflationary pressures, particularly the 3.3% year-on-year rise in core inflation (excluding fresh food) and the 8.2% surge in staple food prices. While the BoJ has paused further hikes for now, its forward guidance remains unambiguous: rates will continue to rise “as underlying inflation approaches the 2% target.”

The BoJ's measured approach is a balancing act. On one hand, it seeks to normalize monetary policy to align with global trends, particularly the U.S. Federal Reserve's tightening cycle. On the other, it remains wary of U.S. tariffs on Japanese exports, which could dampen growth and force a policy reversal. This duality creates a unique environment for the yen: its strength is underpinned by rising rates, yet its trajectory remains contingent on external risks.

Structural Current Account Surplus: A Long-Term Anchor for the Yen

Japan's current account surplus has reached record levels, hitting ¥30.4 trillion in fiscal 2024—the highest since 1985. This surplus is not a fleeting phenomenon but a structural feature driven by Japan's massive overseas investment portfolio. With ¥327 trillion in direct foreign holdings as of Q1 2024, Japan's primary income surplus—boosted by a weak yen—has become a cornerstone of its balance of payments.

The weak yen has amplified the yen-denominated value of foreign earnings, particularly from Asian subsidiaries. For instance, a 1% appreciation in the U.S. dollar against the yen could erase ¥1 trillion in repatriated profits for Japanese multinational firms. Yet, this same dynamic suggests the yen is undervalued relative to its fair value. Purchasing power parity (PPP) metrics and trade-weighted exchange rate indicators both point to a yen that is 15–20% undervalued compared to its long-term average.

Equity Market Implications: Winners and Losers in a Stronger Yen

The yen's appreciation has uneven sectoral effects. Exporters, such as automakers and machinery firms, face margin compression as a stronger yen reduces the yen value of overseas sales. Toyota and Sony, for example, have seen their foreign earnings shrink by 3–5% year-to-date due to currency headwinds.

Conversely, domestic-focused sectors and financials stand to benefit. The Nikkei 225's 16x price-to-earnings ratio, above its 15-year average, reflects investor optimism about sectors insulated from yen volatility. Healthcare, consumer staples, and utilities—industries with stable cash flows and less exposure to global markets—are outperforming. Regional banks, which have historically lagged, are also gaining traction as higher interest rates expand net interest margins.

Strategic Positioning: Overweighting JPY and Japanese Equities

Despite the U.S. dollar's near-term strength—bolstered by large fiscal deficits and geopolitical uncertainty—the yen's long-term fundamentals are robust. A structural current account surplus of ¥1.35 trillion per quarter, coupled with a BoJ that remains committed to gradual rate hikes, provides a durable floor for the currency. Moreover, the yen's undervaluation offers a margin of safety for investors seeking a hedge against dollar overreach.

For equities, the key is sectoral diversification. Investors should overweight Japanese companies with strong balance sheets, exposure to overseas reinvestment (e.g., technology and financials), and alignment with demographic and decarbonization trends. Defensive plays in healthcare and consumer staples, as well as cyclical opportunities in construction and utilities, present a compelling risk-rebalance.

Conclusion: A Case for Patience and Precision

The Japanese yen and equity market are at an inflection point. While the BoJ's cautious normalization and U.S. dollar dominance may delay the yen's full re-rating, the structural underpinnings of Japan's economy—its current account strength, undervalued currency, and improving corporate governance—make a compelling case for overweighting JPY and strategically positioned Japanese equities. For investors willing to navigate short-term volatility, the rewards of a long-term, disciplined approach could be substantial.