Japan’s economy contracted by 0.6% in the third quarter (Q3) of 2025, according to final data from Japan’s Cabinet Office. This was below market expectations of a 0.5% decline and followed a previous estimate of a 0.4% decrease.
On an annual basis, the GDP contracted by 2.3% in Q3, compared to a 1.8% contraction in the prior estimate, falling short of the market expectation of a 2.0% decline.
Currency Impact
The USD/JPY currency pair was noted to be trading down by 0.05% at 155.23. A decreasing GDP generally impacts a nation’s currency negatively, reflecting a contracting economy.
Gross Domestic Product (GDP) is used to gauge economic growth over time, often compared between quarters or years. Rapid GDP growth often leads to inflation, prompting central banks to raise interest rates, which can strengthen the currency. Conversely, a fall in GDP generally weakens the currency.
Regarding commodities, higher GDP growth can negatively affect gold prices. This is due to higher interest rates, which increase the opportunity cost of holding gold as opposed to investing in interest-bearing accounts.
This morning’s report confirms Japan’s economy is weaker than anyone anticipated, contracting by 0.6% in the third quarter. This poor performance makes it highly unlikely that the Bank of Japan will consider raising interest rates anytime soon. For us, this solidifies the strategy of using the low-yielding yen to fund investments in higher-yielding currencies.
Interest Rate Gap
The data supports the view that the interest rate gap between Japan and other major economies will persist. For instance, Japan’s core inflation recently eased to 1.8% in November 2025, removing any pressure on the central bank to tighten policy. This is a stark contrast to the United States, where the Federal Reserve’s benchmark rate is holding at 3.5%, providing a significant advantage to holding dollars over yen.
In the coming weeks, we should consider buying USD/JPY call options to position for further yen weakness. Options with a strike price around 157 expiring in January or February 2026 offer a way to profit from an expected rise in the currency pair. This approach effectively limits our potential loss to the initial cost of the options.
For equity derivatives, this economic slowdown could actually benefit the Nikkei 225 index. A weaker yen increases the value of overseas earnings for Japan’s major export-focused companies, which dominate the index. Looking back at the 2022-2024 period, we consistently saw the Nikkei rally when the yen fell, a relationship we believe will hold true now.
