USD/JPY Forecast for 2026
So now that we have the backdrop here, where do we go in 2026? What’s the outlook for all of the key components?
The first one, of course, is the Federal Reserve’s gradual easing, but yields will remain elevated. And I think the keyword here is gradual. I don’t think the Fed’s going to panic, at least not anytime soon. The Bank of Japan may continue to creep towards normalization, but there’s a big question with that. And of course, the yield differentials will remain strongly positive for the US dollar.
Intervention risk is by the Japanese, but I don’t think that’s likely. Inflation in Japan should moderate, limiting some of the Bank of Japan’s urgency. And a short-term driver for this pair, which I think is secondary to yields, will be the risk sentiment of global traders. That’s almost always the case with this pair anyway.
Bullish Scenario
So, let’s lay out both scenarios. The bullish case, which is pretty much my base case, certainly the higher probability, is that yields in the United States remain relatively high despite rate cuts. We’ve already seen that play out. Normalization in Japan remains incremental at best and probably fragile. Global capital continues to favor US dollar assets. I see that in other markets, not just this one, and the carry trade demand remains strong. This is a market that I think continues to grind higher with short-term sharp reversals. In other words, it’s going to behave much as it has over the last three or four months.
Bearish Scenario
The bearish case scenario, which I think is about a 30% chance at this point, is that the U.S. weakens or, for that matter, growth slows sharply, and it compresses yields. I don’t see that happening. I think it’s a very low likelihood. The Bank of Japan accelerates normalization unexpectedly. I think there’s almost no real risk of that. But if we do get a sustained risk-off environment, that does favor the yen. So that is probably the most likely of scenarios that trigger a bearish move.
Coordinated intervention has happened in the past when the yen starts to get too strong or too weak, but I don’t think we’re anywhere near that. The United States dollar would correct lower against the Japanese yen, but likely to remain within a bullish structure longer term. So, I think the bearish case is at best going to be a quarter of the year.
We may see something like that, but overall, I still think without some type of unforeseen external circumstance, the base case scenario is still bullish. Yield differentials, I believe, will remain the primary driver in this pair. Almost every year, that’s the case. It does stay very structurally supported. Pullbacks continue to be temporary and a value that traders can look for. Volatility, of course, will increase right around policy meetings, but again, that’s nothing new.
In 2025, the pair has been driven almost entirely by yield differentials and the Bank of Japan’s reluctance to normalize its policy. Heading into 2026, I think the structural imbalance remains intact, thereby continuing more of the same.
Levels to Watch
A couple of the levels that I am watching from a technical analysis standpoint would be the 158 yen level. If we can break above there, it opens up 160, possibly even 162. Short-term pullbacks, I think, are very likely, but when you look at the last couple of years, we have formed a massive W pattern. Now all we need is something to kick this thing off to the upside.
Another level that I’ll be watching closely is the 153 yen level, because if we break down below there, we may go back to the 150 yen level, which, as I mentioned previously, has acted like a magnet. I would be very interested in buying the dollar down there. It’s almost like getting a redo of the last three or four months.
At this point, I suspect the base case scenario for this is bullish, and traders will continue to look at every short-term pullback as a potential buying opportunity in what I think is one of the easiest pairs to hold on to, especially as you get paid at the end of every session to do so.
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