Investing.com – has dropped sharply over the past four weeks, and Citi Research sees the pair as vulnerable to increased selling over the passage of time.

At 08:55 ET (12:55 GMT), USD/JPY traded 1.8% higher at ¥146.88, with the pair bouncing after Bank of Japan officials earlier Wednesday downplayed expectations of additional interest rate hikes.

BOJ Deputy Governor Shinichi Uchida said the bank will not hike interest rates when markets are unstable – comments that come after volatile moves in the Japanese currency. 

However, the yen remained well above 38-year lows hit this year, with the pair having dropped sharply over the past four weeks, from a high of almost ¥162 reached last month.

Yen’s weakness was largely predicated on record low interest rates in Japan, which promoted the hugely popular yen carry trade.

That trade involved borrowing the yen then using it to buy currencies with better yields. As a result the yen has been the funding currency of choice for carry trades in U.S. dollars, Mexican pesos, New Zealand dollars and some others.

However, the viability of this trade was called into question when the Japanese authorities started intervening to support their beleaguered currency, before starting to unravel properly when the Bank of Japan hiked interest rates last week.

Japan’s overnight rate is just at 0.25% while dollar rates are roughly 5.5%, but carry trades are more sensitive to currency moves and rate expectations than the actual level of rates.

“The interest rate spread and risk-reward balance for the JPY carry trade have not yet met the conditions prevailing in the past when the USD/JPY has entered a downtrend,” said analysts at Citi Research, in a note dated August 7. 

“However, intervention to buy the JPY by the Japanese government since 2022 has caused a change in underlying supply/demand and may therefore have accelerated the peak for the USD/JPY. In this case, the pair may not return to its high of last month, but instead be vulnerable to increasing downside scope over the passage of time.”

 The bank looks for the USD/JPY pair to decline below ¥140 in 2025, ¥130 in 2026, and ¥120 in 2027.