The Japanese Yen has struggled to build on recent gains despite expectations for further Bank of Japan policy tightening, but MUFG believes investors are overlooking a structural shift that could provide significant long-term support for the currency.

The US Dollar to Japanese Yen exchange rate (USD/JPY) traded close to recent cyclical highs on Friday, with the Yen remaining under pressure from higher oil prices and resilient US economic data.

MUFG argues that the Yen’s recent weakness masks an important structural change in Japanese investment behaviour, as the Government Pension Investment Fund (GPIF) and other institutional investors steadily increase allocations to domestic assets.

“We would still argue that it marks a notable turning point from the Abenomics era.”

The bank believes Japan is gradually reversing the policies introduced more than a decade ago, when pension funds were encouraged to reduce domestic bond holdings in favour of overseas and riskier assets.

“There is though some evidence that flows have already started to shift.”

MUFG highlights a sustained increase in purchases of Japanese government bonds by trust banks since 2021, noting that the GPIF’s domestic bond allocation has already risen from 23.9% at the end of fiscal 2019 to 26.9% today.

If allocations eventually move towards 31%, MUFG estimates that could generate around ¥12 trillion of additional demand for Japanese government bonds, even before allowing for future growth in the pension fund.

Near-Term Japanese Yen Forecast: BoJ Rate Hike Could Accelerate the Trend

MUFG believes the Bank of Japan now has an opportunity to reinforce this shift towards domestic investment.

“The BoJ now needs to show it is not constrained by the government.”

With household inflation expectations at their highest level since 2006, the bank argues that a September interest rate increase would strengthen confidence that policymakers remain committed to normalising monetary policy.

“Hiking in September would be the best way to do that and would go some way to helping turn the yen stronger.”

While geopolitical tensions in the Middle East and higher oil prices continue to support the US Dollar in the near term, MUFG believes Japan’s evolving pension investment strategy represents a significant longer-term positive for the Yen that markets have yet to fully price in.