Let the future tell the truth, and evaluate each one according to his work and accomplishments. – Nikola Tesla
Let the future tell the truth, and evaluate each one according to his work and accomplishments.
Few relationships in global macroeconomics have been as durable – or as closely watched – as the link between interest rate differentials and currency valuations. The chart above, comparing the U.S.-Japan five-year yield differential with the U.S. dollar (USD)/Japanese yen (JPY) since 2016, reflects that history: When yield spreads widen, the yen typically weakens; when they compress, the yen stabilizes or strengthens. What stands out today is not that this relationship has failed, but that it has become less sufficient as broader macro constraints assert themselves.
The most dramatic test of the relationship came in 2022. U.S. five-year yields surged as the Federal Reserve embarked on its most aggressive tightening cycle in four decades while Japan remained pinned near zero. Yield differentials exploded to more than 4%, with USD/JPY climbing past 150 and briefly touching levels not seen since the late 1990s.
The more interesting story emerges in the two years that followed, once the initial shock began to fade. Beginning in late 2022, markets priced the end of the Fed’s hiking cycle, and by late 2023, U.S.-Japan yield spreads had started to compress. Over that period, USD/JPY largely moved with rates, oscillating between roughly 130 and 160, while as of April 2025, the five-year spread was still near 3% and USD/JPY was trading around 140.
That alignment would not hold for long.
The latest move in the chart is perhaps the most revealing. In late 2025, the U.S.-Japan five-year differential fell sharply toward 2%, yet USD/JPY did not follow it lower. Historically, a narrowing of this magnitude would have pointed toward yen strength. This time, it did not.
Instead, the persistence of the divergence reflects forces that are not easily resolved by marginal changes in rate differentials alone. At the same time, the Bank of Japan’s move away from ultra-easy policy has unfolded within clear limits. Inflation, debt dynamics, and Japan’s exposure to global trade and commodity prices constrain how far normalization can proceed without creating new stresses. Together, these forces help suggest why USD/JPY has remained insensitive to narrowing spreads.
What the Chart Suggests Going Forward
Fiscal dynamics, inflation and the reordering of global capital flows are exerting a growing influence as Japan operates within tighter policy and balance-sheet constraints.
In that context, the yen’s behavior is less about undervaluation against historical rate relationships and more about the limits of adjustment in the current regime. The key variable to watch is not the level of short- or intermediate-term spreads but the behavior of Japan’s long-end yields. As we discussed previously when Japan’s long bond broke higher, pressure at the long end has proved to be where constraints begin to surface.
In global macro, regime shifts rarely announce themselves. They emerge unevenly, through relationships that stop behaving the way they once did. This chart does not offer a forecast, but it does hint that Japan might be signaling pressures other developed markets have yet to confront.
Between the Lines is a weekly blog by DoubleLine Portfolio Managers Sam Garza, Joseph Mezyk and Quant Analysts Fei He, CFA and Sunyu Wang that breaks down topical macro and market issues. For questions or suggestions please e-mail us at betweenthelines@doubleline.com. The views and opinions expressed herein are those of the authors and do not necessarily reflect the views of DoubleLine Capital LP, its affiliates or employees.
