After a period of relative stability from 2017 through 2020, traders in the foreign exchange markets pushed the yen’s value down by 59% against the dollar.
But recently, that market-derived valuation was no longer acceptable to the fiscal and monetary authorities of Japan and the United States.
As a result, the Bank of Japan and U.S. Treasury staged what looks to be a $34 billion to $36 billion coordinated intervention into foreign exchange markets this past Friday.
Get Joe Brusuelas’s Market Minute commentary every morning. Subscribe now.
While the rationale for this intervention was parsed in diplomatic terms, in truth it represented an opportunistic policy action by both institutions that were conducted for different reasons.
For Japan, the objective was to prevent a disorderly depreciation of the yen without the Bank of Japan lifting its policy rate to address rising inflation and avoid changing domestic policies that result in capital outflows, which supports the globally important carry trade.
For the United States, the Treasury intervened to suppress the recent increase in yields along the maturity spectrum from 5 to 30 years that occurred following the Federal Reserve’s meeting on July 29.
In addition, the Treasury wanted to avoid the prospect of Japan, with $1.1 trillion in U.S. Treasury holdings, needing to sell Treasury notes to purchase yen, which would have put further upward pressure on U.S. yields.
Just as important was the fact that the U.S. Treasury Department’s sale of euros to purchase yen—a far less liquid market than dollar-yen—was most likely intended to avoid pushing down the greenback, which has also increased following the Fed policy meeting.
Not to be lost in the significant policy action was the Bank of Japan’s use of the Federal Reserve’s Foreign and International Monetary Authorities Repo Facility.
That facility allows other central banks to use Treasury holdings as collateral to access dollars rather than selling them on the open market, which would send U.S. yields higher.
But will this work?
In our evaluation this policy action will be successful in the near term. The move has punished speculators that were targeting the 170 level against the dollar.
Verbal intervention through repeated statements about a willingness to sustain that intervention will most likely delay, but not derail, further depreciation of the yen save a narrowing of the interest rate differential between the U.S. and Japan.
Essentially, if the Bank of Japan does not hike its policy rate at the next meeting on Sept. 17-18, one should anticipate a further depreciation of the yen, and we would not be surprised to see the yen-dollar exchange rate migrate back above 160 as that date approaches.
But the problems in Japan are structural—a 237% debt to gross domestic product ratio—so the appreciation of the yen over the past few days will most likely not prove durable.
Why is this important?
Japan plays a unique role in the global economy and international financial markets. Its long period of using a zero-interest-rate policy created what is known as the carry trade, where traders borrow yen at low rates and invest that money in higher-yielding foreign assets.
That trade plays an important role in the daily global foreign exchange market that is approaching $10 trillion per day.
An increase in the Bank of Japan’s policy rate or intervention into FX markets that result in an appreciation of the yen carries with it implications for global rate markets.
Traditionally, the Bank of Japan intervening to support the yen would result in a depreciation of the dollar as U.S. Treasuries are sold to purchase yen, which means rising American yields.
But in this case the coordinated nature of the intervention and the unusual action of the U.S. Treasury selling euros to purchase yen have resulted in a temporary decline in U.S. yields.
On Monday, the U.S. 10-year yield had declined by roughly 1% to 4.68% from Friday’s 4.73% close.
Because the cost of borrowing is set in global markets, small and medium-size businesses need to be more attuned to what happens on the other side of the international dateline that would normally be the case.
While Japan has often intervened in the foreign exchange markets, this joint intervention is truly a global financial event because of the level of debt carried by both economies.
It is signaling that the risk of rising debt levels for both the Japanese and the U.S. governments is rising, as seen in rising long-term interest rates in both domestic markets.
Both governments have turned to what has often proved to be easily reversible policy moves, with the markets having the last word on sustainable fiscal and monetary policies.
While we do not expect a Plaza or Louvre Accord moment, it illustrates the consequences of the Ministry of Finance’s extended zero-interest rate policy and the carelessness of U.S. fiscal policy, with the markets having the last word.
The takeaway
Japan and the U.S. engaged in a coordinated intervention into global currency markets which caused the yen to appreciate from just above 163 to the dollar to just below 157 on Monday afternoon.
While the Bank of Japan and U.S. Treasury have their own varied interests, the appreciation of the yen, the desire to avoid a disorderly devaluation of the Japanese currency as well as the large selling of U.S. Treasuries that would send yields higher created the unusual conditions for this rare event.
But that unique confluence of interests will dissolve. By the time of the next Bank of Japan meeting, the U.S. will be far more interested in a rate hike out of the Bank of Japan, which will narrow the interest rate differential between the two economies and favor an appreciation of the U.S. dollar.
That dynamic stands in contrast to the preferences of the Takaichi government, which is on record as recommending the Bank of Japan move cautiously in its normalization of monetary policy as the cost of servicing Japanese government debt rises.
This is why the intervention can be looked at as a short-term success but will not result in a weaker yen.
We still think that the yen is moving toward 170 in 2027 despite the money on the table put forward by the Bank of Japan and U.S. Treasury.
