Japan likely used its holdings of foreign securities, including U.S. Treasury bonds, to fund the record-scale foreign exchange market interventions conducted over the past month. This move could draw attention from the United States.
Data on foreign exchange reserves released by Japan's Ministry of Finance shows that as of the end of May, Japan's holdings of foreign securities decreased by $75.6 billion compared to the end of April. This amount roughly corresponds to the scale of funds deployed by Japan to support the yen in the market between late April and early May. Japan's Ministry of Finance had previously confirmed that its currency market interventions reached a record 11.73 trillion yen ($73.4 billion) in the one-month period ending May 27th.
During a briefing on the report, a Ministry of Finance official acknowledged that the forex intervention was one factor behind the significant decline in foreign reserve holdings, adding that it was the largest drop on record.
Following the record intervention, the decline in Japan's foreign securities holdings in May, linked to the selling of U.S. Treasuries for intervention purposes, may not be welcomed by U.S. authorities. The core of U.S. concern lies in the fact that Japan's intervention funds primarily come from selling U.S. Treasury bonds. Sustained selling could further push up U.S. bond yields, exacerbating volatility in U.S. financial markets.
Against the backdrop of Middle East conflicts driving up oil prices and intensifying global inflation concerns, U.S. bond yields were already on an upward trajectory. Japan's bond-selling actions add fuel to the fire, further heightening U.S. anxiety.
With the U.S. fiscal deficit continuing to widen and Treasury issuance surging, a Trump administration would be unlikely to tolerate policy fluctuations in Japan indirectly pushing up already elevated U.S. bond yields. U.S. officials have grown increasingly concerned about the stability of the U.S. Treasury market in recent years.
Earlier this year, U.S. Treasury Secretary Beth Zent warned Japan that volatility in the Japanese bond market could spill over into the U.S. Treasury market, highlighting concerns about large-scale selling of U.S. Treasuries by foreign holders. During last month's G7 finance ministers' meeting in Paris, a senior Japanese Ministry of Finance official stated that authorities were aware of the risks posed by selling U.S. Treasuries, as it could push up yields, potentially leading to further yen depreciation and thus counterproductive effects.
Economist Hirokazu Fujishiro from the Dai-ichi Life Research Institute commented, "Japan ultimately conducted the intervention. Therefore, a natural interpretation is that the U.S. is willing to tolerate a certain level of risk from rising U.S. Treasury yields."
Japan's Finance Minister, Tsukasa Katayama, previously stated in parliament that, according to the U.S.-Japan joint foreign exchange statement, Japan has the right to take "decisive action" (typically referring to forex intervention). This statement appeared to defend Japan's actions. She also indicated that the government stands ready to respond appropriately to exchange rate movements if necessary, warning speculators that authorities could take further action.
It is worth noting that the price of the 10-year U.S. Treasury note declined compared to the end of April, meaning a small portion of the decrease in foreign securities holdings might be attributed to valuation declines in U.S. Treasury holdings. Furthermore, data shows Japan's foreign exchange reserves fell to $1.09 trillion by the end of May, indicating that Japan still possesses substantial resources for potential future intervention.
Another potential funding source for intervention—foreign currency deposits—remained largely unchanged at $162 billion. While the data does not provide a detailed breakdown of the securities portfolio structure or bond maturities, market participants estimate that approximately 70% of Japan's foreign exchange reserves are invested in U.S. Treasury bonds.
Data from U.S. Treasury holdings in Federal Reserve custody accounts also suggests Japan likely sold some U.S. securities to fund its recent yen purchases. Fujishiro noted, "If Japan is selling ultra-short-term U.S. Treasuries, the impact on the U.S. might be limited. But if Japan sells a large amount of 10-year U.S. Treasuries, disrupting the supply-demand balance in that market, the situation would be entirely different."
So far, the U.S. has shown little public opposition to Tokyo's actions this year to support the yen. During her visit to Tokyo last month, Secretary Zent stated that excessive exchange rate volatility is undesirable. This was interpreted by the market as implicit U.S. support for Japan's measures to curb abnormal market fluctuations.
Zent also expressed confidence in Bank of Japan Governor Ueda Kazuo, hinting that the U.S. might hope Japan will raise interest rates further, thereby helping the yen appreciate. The Bank of Japan, as expected, raised its policy rate by 25 basis points last week to 1%, the highest level since 1995.
The central bank also noted that the risk of underlying inflation exceeding the 2% target is rising, suggesting room for further rate hikes later this year. However, raising borrowing costs alone may not be sufficient to reverse the depreciation pressure on the yen.
The Bank of Japan's rate hike last week provided little support for the yen. This implies that if the yen comes under pressure again, the Japanese government may still take further intervention action. At the time of writing, the USD/JPY exchange rate was 161.69. The next key level for the yen is 161.95 yen per dollar; a break below that would mark its lowest level since December 1986.
The U.S. Treasury Department is expected to release its semi-annual foreign exchange report by the end of this month. The report may provide further insight into how Washington assesses Tokyo's recent actions. In the foreign exchange report issued in January, the U.S. stated that Japan remains one of ten economies on its monitoring list. The exchange rate policies and macroeconomic policies of these major trading partners are deemed to warrant continued close attention.
Fujishiro concluded, "From the U.S. perspective, if the yen remains persistently weak and Japan is forced to intervene repeatedly, it may eventually require selling more U.S. Treasuries. Precisely because of this, I believe Washington also views excessive yen depreciation as undesirable."
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