The Japanese yen is at a 40-year low. Here’s why that matters

(CNN) — The Japanese yen has dropped to a 40-year low against the US dollar, putting investors on watch for potential government intervention by Japan that could ripple through US stocks, the Treasury market and the broader global economy.

The yen’s decline to its lowest level since 1986 has been fueled by a recent shift in expectations for US interest rates, largely due to the war with Iran; and a rebound in the dollar.

The Japanese government stepped in to prop up the yen earlier this year, but failed to halt its slide. With the currency now at fresh multi-decade lows, traders are bracing for another attempt.

Here’s what’s going on:

Why is the yen sinking?

Traders are betting the US Federal Reserve will likely hold rates steady, or even increase them, in the coming months, to combat inflation spurred by the oil shock from the US-Israeli war with Iran.

That shift in the Fed’s outlook has led to a strengthening of the dollar, putting pressure on the yen and other currencies. The US dollar index is up 3% this year, rebounding after tumbling 9% in 2025.

“The energy price shock triggered by the US-Iran war has been the last catalyst for a weaker yen, which has been reinforced by the recent hawkish shift in Fed policy communication,” Lee Hardman, senior currency economist at MUFG, said in an email.

Currencies typically rise and fall based on differences in interest rates in different countries. The Bank of Japan on June 16 raised its benchmark interest rate to 1% – the highest level since the 1990s. But the BOJ’s interest rate is still considerably lower than that of the Fed, which in June held its rate steady at a range of 3.5% to 3.75%.

That gap is pushing money towards the US and away from Japan as investors chase better returns, strengthening the dollar – and pushing the yen lower – while increasing volatility across global markets.

The Supreme Court on Monday also ruled that President Donald Trump cannot fire Fed Governor Lisa Cook without evidence of any wrongdoing, bolstering the central bank’s independence. The Fed’s assertive attitude toward inflation, coupled with the reinforcement of the Fed’s independence, have supported the dollar (and pushed the yen lower).

The Japanese currency in recent months was at its lowest level against the dollar since 2024, but in recent days it slipped below that level to its lowest point since the 1980s.

What does a weak yen mean for Japan?

Japan had extraordinarily low interest rates – zero to negative – across the 2000s and 2010s to try and juice the economy and prevent deflation after the country’s economy went into a severe recession in the 1990s.

In 2024, the BOJ began raising interest rates as the country began to experience inflation above the central bank’s target of 2%. But the yen has continued to decline as Japan’s interest rates remain lower compared to the rest of the world.

A runaway slide in the currency – paired with stubborn inflation – could spark an economic crisis. A weaker currency can make imported goods more expensive, and Japan imports much of its food and energy. The US-Israeli war with Iran and the surge in oil prices has had outsized impacts on Asian economies that are reliant on oil from the Middle East.

“Japanese officials have made it clear that the weak yen poses a threat to import costs and Japan’s cost of living crisis, which has been a key topic for the electorate,” Chris Turner, global head of markets at ING, said in a note.

How would Japanese intervention impact US markets?

The Japanese government could boost its currency by selling US dollars or assets denominated in dollars, like US Treasuries, and then buying yen. Intervention could come as soon as this weekend, according to Turner at ING.

A jump in the yen could move financial markets by putting pressure on the dollar and Treasuries.

The government has intervened in markets before – as recently as earlier this year. Japan sold about $70 billion in assets in late April and early May in an effort to boost the yen, according to ING. There was minimal impact on US markets, but the intervention failed to address the underlying problems.

If Japan were to sell more of its US Treasury holdings, it could push yields higher. Yields rise when bond prices fall. Analysts say, however, that the overall effect would be modest, given the size of the US bond market.

“Japanese currency intervention efforts are typically conducted at a scale far too small — tens of billions against roughly $29 trillion in marketable Treasuries — to have a material impact on US yields,” Karl Schamotta, chief market strategist at Corpay, said in an email.

For the stock market, there are still implications. A popular trade on Wall Street involves borrowing yen to invest in US stocks, which is relatively affordable because of the BOJ’s history of near-zero interest rates.

But if the yen spikes in value because of government intervention while the BOJ is raising rates, borrowing suddenly becomes more expensive. That could unwind the so-called “carry trade.” Traders would have to sell their stocks to pay back their loans.

“A ‘shock and awe’ campaign involving much larger trading volumes, especially if coordinated with the US Treasury, could trigger a violent unwind in the carry trade, however, with severe negative implications for US equity markets,” Schamotta added.

In August 2024, an unwinding of this so-called “carry trade” – sparked by the BOJ raising interest rates that July – led to a sharp sell-off in US stocks, particularly tech stocks.

What does this all mean for you?

Currency markets have direct implications for the US stock market – where trillions of dollars of Americans’ savings are tied up in retirement accounts. As markets become increasingly algorithm-driven, wonky moves in currency markets matter for stocks.

Volatility in the carry trade would come as some analysts are already concerned about how far AI and tech stocks have run this year.

And the yen trading at 40-year lows – while the dollar is rebounding – also reflects how wild markets have been this year.

“Where we stand at mid-year is a testament to the sheer unpredictability of this moment,” Schamotta said. “In January, most observers expected a continued decline in the dollar and a recovery in the yen. In the face of massive dislocations in the global economy, both of those assumptions have been decisively overturned.”

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