The USD/JPY pair has broken its historical correlation with US-Japan yield spreads, with correlations turning negative as Japan-specific risks dominate. Fiscal concerns under the new administration could keep the yen weak even if spreads continue to compress, said Lee Hardman and Abdul Ahad Lockhart, currency analysts at MUFG.
USD/JPY fair value divergence widens
“The recent relationship between USD/JPY and USD/JPY yield spreads confirms a structural shift in USD/JPY dynamics. Historically, the pair has closely followed short-term US/JPY spreads, making the two-year spread an essential input into our short-term fair value model alongside implied volatilities, risk reversals and other macro features.”
“However, since October, our regression models have shown a persistent misvaluation between spot value and fair value. This divergence coincides with a sharp decline in the correlation between USD/JPY returns and USD/JPY yield spreads: before October 2025, the rolling average 12-week correlation with the 10-year average spread was +0.43, peaking at 0.91 in February, while the average correlation after October 2025 collapsed to -0.07 with the eight-week spread.” Consecutive negatives up to the present.”
“We interpret this as USD/JPY price action reflecting Japan-centric risk factors rather than US interest rate dynamics. This shift is due to financial uncertainty resulting from Sanae Takaishi taking over as Prime Minister and the larger supplementary budget. As a result, upcoming policy decisions from the Bank of Japan and the Fed may exert less directional influence on USD/JPY than in previous regimes. If financial concerns persist, the yen may remain weak even as yield spreads continue to tighten.
