Yen Slides Back Towards 160, Wiping Out Half of Joint Intervention Gains
US Treasury Secretary Scott Bessent's suggestion of unlimited support to rescue the Japanese yen is being met with skepticism from market participants, who question the actual firepower at his disposal. On Monday, the yen fell by as much as 1%, erasing half of the gains from the first joint US-Japan intervention since 1998. After the intervention on July 31, the yen briefly approached 155 against the dollar, but has since fallen past the 159 mark.
Following that unusual coordinated action, Bessent stated, "We will support them with everything we have, to help the US economy, US taxpayers, and stabilize the global economy." The problem is that Bessent appears limited in his exchange rate intervention ammunition, primarily constrained by the Exchange Stabilization Fund, which stands at less than $220 billion. In comparison, Japan is estimated to have spent $53 billion on yen operations on July 30 alone, the day before the coordinated US-Japan action.
"The US can influence the narrative through coordinated intervention with Japan, but it cannot change the underlying fundamentals," said Nathan Thoft, senior portfolio manager at Manulife Investment Management. Regarding the US authorities' capacity, he added, "They have deep pockets, but not unlimited ones."
The Fed's 'Unlimited' Firepower Remains on the Sidelines
In theory, the Federal Reserve has unlimited firepower for foreign exchange intervention to weaken the dollar, as it can effectively create dollars. However, during last month's action, the Fed's role was limited to physically executing yen purchases on behalf of the US Treasury. Historically, the Fed has sometimes used its own funds to intervene jointly with the US Treasury as a show of support. For example, the 1998 yen intervention saw the Fed and Treasury each contribute 50%. Similar equal funding splits were used for the joint yen-selling operation in 2011 and the joint euro-buying in 2000.
Derek Tang, an economist at Monetary Policy Analytics, said Monday that media reports suggest the Fed "did not put up any money" to support the US intervention. Official data may not confirm this until later this year. Tang noted the Fed's "intervention capacity is theoretically limited only by its own willingness." The Fed declined to comment on the US intervention on Monday, and the US Treasury did not respond to requests for comment.
Bessent highlighted another avenue where the Fed could help: the Foreign and International Monetary Authorities Repo Facility (FIAM). This tool allows Japan to swap a portion of its over $1 trillion US Treasury reserve holdings for dollar cash. Two days after the intervention, Bessent suggested "expanding" the facility's size. Data released by the Fed last Thursday showed Japan has not yet used the facility. However, earlier this month, Japanese Finance Minister Satsuki Katayama hinted that the tool might be utilized at some point in the future.
Market Focus on the 160 Threshold
If the yen breaks through the key psychological level of 160 against the dollar, intervention pressure is likely to rise, whether through unilateral Japanese action or a renewed US-Japan joint effort. Authorities stepped in to support the yen when it fell below that level in the summer of 2024.
"If the US and Japan allow the yen to trade sustainably above 160, the market could interpret the lack of intervention as a signal that the US is unwilling to sell dollars," wrote Marco Carzigi and Lu Gang of Evercore ISI in a report on Monday. "This could invite additional market pressure, testing everyone's commitment to a stronger yen."
Economists and market participants believe Bessent's primary motivation for supporting the yen is likely to prevent contagion from spilling into US Treasuries. Selling of Japanese government bonds occasionally spills over into US Treasuries, and if Tokyo sells dollars, it could push US yields higher. The benchmark 10-year US Treasury yield recently hit its highest level since Bessent took office.
"If Bessent is worried that yen trading could put upward pressure on US Treasury and long-end US bond yields, the best way to address this is to curb US fiscal profligacy," said Mark Sobel, a former US Treasury official with three decades of service. "FX intervention and using the FIMA facility are just band-aids."
Macro strategist Skylar Montgomery Koning said, "The yen's renewed weakness, combined with higher US Treasury yields, could prompt Washington to re-engage. If the US ultimately sells dollars, rather than euros as in July, it would constitute a stronger deterrent for investors still short the yen."
Yen Depreciation Pressure Expected to Re-emerge
With Japan on holiday Tuesday, traders are cautious that thinning liquidity could create conditions for a new round of intervention, as authorities might achieve greater impact with less effort. However, Monday's exchange rate volatility highlighted the limitations of intervention in changing the yen's overall trend, especially as key factors behind its depreciation remain. These include the massive interest rate differential between Japan and the US, concerns about Japan's fiscal outlook, and geopolitical uncertainty.
On Monday, the yen's decline coincided with a rise in oil prices due to ongoing tensions over the Iran situation. Japan relies heavily on energy imports, making it vulnerable to higher oil prices. In terms of policy rates, the Bank of Japan's benchmark rate stands at 1%, while the Fed's key rate is in a target range of 3.5% to 3.75%. Minutes from the BOJ's latest policy meeting showed rising risks of inflation, with one member suggesting the pace of rate hikes could accelerate.
Swaps indicate traders see about a 63% chance of a BOJ rate hike in September, while an October move is almost fully priced in. "We believe the market's relatively subdued reaction to this intervention underscores the underlying reasons for the yen's weakness," wrote strategists including Kamakshya Trivedi at Goldman Sachs. The team expects "yen depreciation pressure will re-emerge over time unless there is a change in global circumstances or an unexpected policy shift."
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