According to Japanese government officials, Bank of Japan Governor Kazuo Ueda's strong signal of a potential September rate hike was a key factor that facilitated the recent joint U.S.-Japan action. The United States believes that the expectation of higher interest rates helps alleviate yen depreciation pressure, thus supporting Japan's efforts to stabilize the currency through both monetary policy and market intervention.
U.S. Treasury Secretary Bessent subsequently stated that the U.S. would do "everything in its power" to support Japan in stabilizing the yen, adding that such actions would benefit the U.S. economy, American taxpayers, and global financial stability. However, market participants believe the U.S. Treasury has limited resources directly available for currency market intervention, and Bessent's pledge may face practical constraints.
The U.S. Treasury's primary tool, the Exchange Stabilization Fund (ESF), has less than $220 billion in assets. In contrast, Japan is estimated to have spent approximately $53 billion on July 30 alone to support the yen. Nathan Thooft, Senior Portfolio Manager at Manulife Investment Management, noted that while the U.S. can influence market expectations through coordinated intervention with Japan, it cannot change the fundamental factors driving exchange rates. "The financial firepower is strong, but it is not unlimited," he said.
The Federal Reserve has theoretically unlimited ammunition, but it has not directly contributed funds this time. The U.S. possesses greater intervention capability through the Fed, which, by virtue of its ability to create dollars, is constrained only by policy intent rather than funding size. Nevertheless, during the July 31 yen intervention, the Fed's role was primarily to execute yen purchases on behalf of the U.S. Treasury. Market reports indicate the Fed may not have used its own funds. Derek Tang, an economist at Monetary Policy Analytics, said official data confirming this is not expected until later this year.
Historically, the Fed has frequently participated in currency market operations alongside the Treasury. During the 1998 yen intervention, the Fed and Treasury shared costs on a 50-50 basis. Similar arrangements were used for the joint yen-selling operation in 2011 and the euro-buying operation in 2000. Bessent is also focusing on another support mechanism: the Fed's Foreign and International Monetary Authorities (FIMA) Repo Facility. This allows Japan to use its over $1 trillion in U.S. Treasury reserves to obtain dollar liquidity. Two days after the July 31 intervention, Bessent suggested expanding the facility's size. However, the latest Fed data shows Japan has not yet used this facility. Japanese Finance Minister Katusa Sasaki previously indicated that the FIMA facility might be utilized at some future stage.
The market is now focused on whether the yen will again breach the psychologically critical level of 160. When the yen fell below this level in the summer of 2024, the Japanese government intervened. Marco Casiraghi and Gang Lyu, analysts at Evercore ISI, said that if the U.S. and Japan allow the yen to remain above 160, the market could interpret this as a lack of U.S. willingness to push the dollar lower, potentially reigniting short pressure on the yen.
Analysts believe one key reason for Bessent's push to stabilize the yen is to prevent exchange rate volatility from impacting the U.S. Treasury market. Past sharp adjustments in Japan's bond market have transmitted to the U.S. bond market, and if Japan were to sell dollar-denominated assets, it could push up U.S. Treasury yields. Mark Sobel, a former U.S. Treasury official, argued that if Bessent is concerned about the yen's trajectory driving up U.S. long-term interest rates, the truly effective solution is to improve U.S. fiscal conditions, not rely on currency intervention. "Foreign exchange intervention and the FIMA facility are just band-aids," he said.
Skylar Montgomery Koning, a strategist at Bloomberg, suggested that if the yen continues to weaken alongside rising U.S. Treasury yields, the U.S. might intervene again. Should the U.S. choose to sell dollars in the future, as opposed to selling euros in previous operations, it would create a stronger deterrent for investors still holding short yen positions. Meanwhile, the Japanese market was closed on Tuesday for a holiday, reducing trading liquidity and potentially amplifying exchange rate volatility, which could make intervention more efficient. However, the market consistently believes that a single intervention is unlikely to change the yen's long-term trend, as the factors driving its depreciation persist.
The interest rate differential between Japan and the U.S. remains significant. The BOJ's policy rate stands at 1%, while the Fed's federal funds rate target range is 3.5% to 3.75%. Additionally, Japan's fiscal outlook, geopolitical risks, and rising energy prices continue to pressure the yen. Given Japan's heavy reliance on energy imports, rising oil prices due to tensions in Iran have added to the yen's downside risk. The latest BOJ policy meeting minutes show that some board members believe the risk of accelerating inflation is rising and suggested that the pace of rate hikes could be quickened. Interest rate swap markets indicate traders assign roughly a 63% probability to a BOJ rate hike in September, with a move in October almost fully priced in. A team led by Goldman Sachs strategist Kamakshya Trivedi stated that the market's limited reaction to the intervention reflects the yen's weakness being primarily driven by fundamental factors. Unless there is a significant change in the global environment or policy, the yen is likely to face renewed depreciation pressure in the future.
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