Japanese Prime Minister Sanae Takaichi issued a stern warning against financial market speculation on Sunday, pledging to take necessary measures to counter abnormal fluctuations. This comes after the yen experienced sharp swings on Friday, recording its largest single-day gain in five months, with widespread market speculation that a "rate check" by the New York Fed signaled potential coordinated US-Japan intervention in the currency market. During a televised party leader debate on Sunday, Takaichi explicitly stated that while a prime minister should not comment on market-determined matters, the government "will take all necessary measures against speculative and extremely abnormal volatility." Although she did not specify whether this pertained to bond yields or exchange rates, her remarks, made amidst rising Japanese bond yields and sustained pressure on the yen, have intensified expectations for official intervention. This sense of urgency stems from the market's dramatic reaction last Friday. As previously noted, following trader reports that the New York Federal Reserve had contacted financial institutions to inquire about exchange rates, the yen staged a significant reversal, rallying twice during the session. The USD/JPY pair plunged approximately 1.75%, hitting a low of 155.63, its weakest level since December 24 of last year. The market interpreted the Fed's move—often seen as a precursor to intervention—as a crucial signal that the United States is prepared to assist Japan in bolstering the yen. Although Japanese officials declined to confirm intervention rumors, with Finance Minister Katsuya Satsuki merely emphasizing they are "closely monitoring developments with a high sense of urgency," the New York Fed's involvement sparked intense discussion on Wall Street about "coordinated intervention." Analysts pointed out that the Fed's action suggests any potential intervention would not be unilateral; this expectation prompted yen shorts to cover their positions rapidly, while also raising concerns that intervention could spill over into the US stock market. The yen's reversal began during the early European trading session on Friday and accelerated during the US afternoon session. The USD/JPY pair fell sharply from its intraday high of 159.23, erasing all gains made since last Christmas. According to Bloomberg, the yen's surge coincided with the New York Fed contacting financial institutions to inquire about the yen's exchange rate. Such rate checks have historically been viewed as warning signals from governments to traders, typically occurring when volatility increases and verbal intervention proves ineffective. Karl Schamotta, Chief Market Strategist at Corpay, colorfully commented: "If a duck looks like, walks like, and quacks like intervention, it's probably intervention." He noted that the yen's exceptionally rapid move suggested either the Japanese government was stepping in or traders were front-running an anticipated action. Bipan Rai, Managing Director at BMO Capital Markets, believes the New York Fed's involvement changes the nature of the market dynamic. He stated that while past rate checks haven't always led to imminent intervention, the fact that the Fed initiated the inquiry implies "any potential intervention targeting USD/JPY would not be unilateral." Krishna Guha, an economist at Evercore ISI, suggested that US participation in foreign exchange intervention is justifiable under current circumstances, with the shared goal not only being to prevent excessive yen weakness but also to indirectly stabilize the Japanese bond market. Even without actual US intervention, such signaling could accelerate the unwinding of yen short positions. Market anxiety about intervention peaked as the USD/JPY pair approached the 160 level. This is the threshold at which Japanese authorities intervened multiple times in 2024, spending nearly $100 billion to support the currency. Brendan Fagan, a Bloomberg Markets Live strategist, noted that 160 has once again become a psychological barrier, and the path for a higher USD/JPY is narrowing amid fiscal uncertainty and capital outflow pressures. This market turmoil coincides with a highly sensitive political period in Japan. The Takaichi cabinet dissolved the House of Representatives last Friday, with a vote scheduled for February 8th, setting a post-war record for the shortest interval between dissolution and voting. Since Takaichi took office as Prime Minister last October, her promised tax-cut policies have raised fiscal concerns, pushing Japanese government bond yields to record highs while the yen has depreciated over 4% during this period. Valentin Marinov, a strategist at Credit Agricole, stated that when the yen exchange rate is so close to the perceived "red line," the market becomes extremely skittish, making it easy to believe that the early stages of official intervention are underway. Last week, volatility in long-term Japanese Government Bonds (JGBs) was also exceptionally severe. The 30-year JGB yield surged 25 basis points on Tuesday, indicating a supply-demand imbalance at the long end of the yield curve. However, Goldman Sachs traders Cosimo Codacci-Pisanelli and Rikin Shah noted in a report that mere market intervention cannot solve the underlying problem. They argue that the supply-demand imbalance for long-term JGBs is severe, exacerbated by the loose fiscal policy stance. Unless the Bank of Japan adopts a more hawkish stance or implements quantitative easing (QE) to stabilize the bond market, both the yen and JGBs will remain under pressure. What can stop this? The Ministry of Finance should and will reduce long-term bond issuance, but that is not enough. The absolute supply of long-term JGBs remains high given such weak demand. Implementing sterilized QE could stabilize the market more quickly, but ultimately, intervention in either interest rates or the foreign exchange market does not address the root cause. Certainly, a shift in fiscal policy direction could change the situation, but that seems highly unlikely at present. Therefore, only monetary policy remains. Does Kazuo Ueda have the capacity for unexpectedly hawkish measures to confront the market? This week's meeting still indicated hesitation, but we believe the BOJ may ultimately be forced to act. For long-term bonds, it remains unclear if these measures would be sufficient to provide support. While current levels are already high, we believe the risk remains skewed towards further price increases until the supply-demand relationship stabilizes. Since 1996, the Fed has intervened in the foreign exchange market on only three occasions, most recently following the 2011 Japan earthquake. However, analysts believe current market conditions might prompt a shift in the US stance. Ed Al-Hussainy, Global Rates Strategist at Columbia Threadneedle Investments, suggested the US Treasury might be nervous about the spillover effects of JGB volatility into the US Treasury market and is exploring currency intervention as a stabilization tool. Leah Traub, Portfolio Manager at Lord Abbett & Co., believes that given the US government's past concerns about currency intervention, "the US appears to be giving a green light" if Japan indeed requires more forceful action. Jason Furman, a Harvard professor and former Chairman of the White House Council of Economic Advisers, commented that neither the US nor the Japanese government seems satisfied with the yen's value, and everyone is highly alert. However, he also cautioned that, historically, rate checks and even actual intervention have not produced lasting effects, and genuine policy changes are needed to achieve that.
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