Citi Says Sharp TOPIX Drop Could Push USD/JPY Lower as Yen Gains Momentum

A significant correction in Japanese equities could trigger a sharp decline in the USD/JPY exchange rate, although Citi analysts believe the stock market would need to fall much further before the Japanese yen strengthens in a sustained way.

Japanese stocks have recently reached record highs, encouraging domestic and international investors to rebalance portfolios and increase currency-hedging activity. According to Citi, these investment flows have contributed to the yen's prolonged weakness as equity markets advanced.

While the Nikkei 225 has pulled back from its recent peak, the broader TOPIX index remains near 4,000, suggesting that the current market correction is not yet large enough to generate meaningful yen appreciation. Historical market trends show that since 2024, the yen has tended to strengthen more aggressively whenever TOPIX declines by more than 10%.

Based on that relationship, Citi estimates that USD/JPY could fall sharply if TOPIX drops toward 3,600, representing roughly a 10% decline from current levels. Such a correction could prompt overseas investors to reduce currency hedges or unwind positions linked to Japanese equities, increasing demand for the yen.

The relationship between Japanese stocks and the currency remains interconnected. A weaker yen typically benefits Japan's export-focused companies by boosting the value of overseas earnings, while rising equity prices often generate investment flows that place additional downward pressure on the currency. Increased stock market volatility has made this dynamic even more pronounced.

However, Citi noted that the correlation between Japanese equities and USD/JPY has weakened since 2025 as the monetary policy gap between the Federal Reserve and the Bank of Japan has narrowed. That shift has provided underlying support for the yen and reduced the currency's sensitivity to rising stock prices.

Using market data since 2025, Citi estimates the current relationship between TOPIX and USD/JPY implies an exchange rate near 160. Applying the stronger historical correlation observed between 2012 and 2024 would suggest a level closer to 175.

Despite the potential for yen strength during a sharp equity selloff, Citi maintains a constructive outlook on Japanese stocks. As long as the bullish outlook for TOPIX remains intact, USD/JPY is likely to stay elevated, although the reduced sensitivity between equities and the currency could limit further yen weakness.