US-Japan Yield Gap Keeps Yen Under Pressure

The interest rate differential between the US and Japan remains a major driver of currency markets. The spread between two-year government bond yields currently stands at around 2.81 percentage points, with the dollar enjoying a significant yield advantage over the yen.

This has led to carry trades, where investors borrow in low-yielding yen to invest in higher-yielding US assets. As long as this yield differential remains elevated, the incentive to hold dollars over yen is unlikely to disappear.

The Bank of Japan's expected tightening policy has further strengthened expectations that Japanese interest rates will rise again during the second half of the year. The policy rate is projected to reach around 1.25% by December, but even with additional tightening, Japanese interest rates would remain well below those in the US.

The Federal Reserve's decision to keep policy restrictive has also contributed to the dollar's strength, as markets expect roughly an 80% probability that rates will remain elevated through September.