The Federal Reserve may soon be drawn into the Trump administration's efforts to support Japan's struggling currency, a key US ally. Treasury Secretary Scott Bessent is pushing the politically neutral central bank to expand a lending facility, allowing Japan to prop up the yen without disrupting the sensitive US Treasury market.
This request comes as incoming Fed Chair Kevin Warsh seeks to reshape the relationship between the Treasury and the Federal Reserve. How they collaborate could significantly impact the management of the $29 trillion Treasury bond market and potentially assign the Fed a new role in supporting US financial diplomacy. It remains unclear how much support Warsh has within the Fed for such a major policy change.
On Sunday, Bessent posted on X that the US had intervened in foreign exchange markets to support the yen. While Japan routinely intervenes to support its chronically weak currency, US participation is extremely rare. The last time the US joined a broader effort to back Japan was after the devastating earthquake and tsunami in 2011. Since 2022, the yen has fallen sharply as the US raised interest rates aggressively while Japan did not. Economists debate the factors behind the decline, including Japan's massive government debt, a shrinking and aging population that drags on growth prospects, and costly energy imports. A weak currency fuels inflation by making imports more expensive, a concern the Japanese government has repeatedly voiced.
According to Factset data, the dollar briefly bought nearly 164 yen last week, the weakest level for the pair since 1986. This prompted the US and Japanese authorities to jointly attempt to support the yen. "Friday's coordinated foreign exchange action curbed disorderly yen volatility," Bessent said on Sunday. The Treasury sold euros from its Exchange Stabilization Fund to finance the yen purchases. By Monday afternoon US time, the yen had bounced 3.5% from its lows to just below 157. The move may also have been aimed at the Treasury market. The interest rate differential between Japan and the US has fueled a long-standing "carry trade" – investors borrow yen cheaply and invest in higher-yielding US Treasuries or the AI-driven US stock market boom. But the outlook for this trade is now in question. President Donald Trump's tariffs and other policies have prompted global investors to hedge their dollar transactions. "The yen carry trade has broken," wrote Torsten Slok, chief economist at Apollo Global Management, in a research note on Sunday.
Stopping the yen's slide could stabilize the carry trade and help sustain demand for US Treasuries. When financial institutions, governments, or central banks sell Treasuries, their prices fall and yields rise. Before the intervention, the 10-year Treasury yield rose above 4.7% last week before edging back below that level. High Treasury yields make borrowing more expensive for consumers and businesses, something Bessent has said he is monitoring closely. Bessent's approach to the intervention also suggests he was mindful of the Treasury market. His department sold euros, not dollars, to buy yen. He also stated that, going forward, he wants Japan to use a Fed lending facility known as the Foreign and International Monetary Authorities (FIMA) Repo Facility. The FIMA facility allows foreign central banks to borrow against their holdings of US Treasuries for short periods, rather than selling them outright. This avoids the political and economic problems that can arise from rising Treasury yields. Central banks often act to support global financial system stability during times of stress. However, in this case, it is unclear whether the long-term pressure on the yen constitutes such a concern for market liquidity or functioning. For example, Japan already has access to the Fed's currency swap line, which allows Tokyo to exchange yen for dollars. But Japan did not use it this time. "In current practice, central bank swaps are used to provide dollar funding for lender-of-last-resort type activities, not for forex intervention," wrote Brad Setser, a former Treasury official now at the Council on Foreign Relations, in an X post.
In his X post, Bessent said he wants to see the FIMA facility "expanded." The repurchase facility has a daily limit of $60 billion per counterparty. US data shows Japan held about $1.1 trillion in US Treasuries as of May. Estimates suggest Japan's recent intervention was between $60 billion and $80 billion. If the FIMA facility were used more broadly, it could make the Treasury market more attractive, broadly easing US fiscal pressure. This idea may have broad political and economic appeal, but it does not necessarily fall within the Fed's traditional mandate. Expanding the FIMA facility would require a vote by the Federal Open Market Committee (FOMC). Warsh may see it as worthwhile. Before assuming the chair, he indicated a desire to rewrite the relationship between the Fed and the Treasury, known as the Treasury-Fed Accord. In his April confirmation process, responding to questions from a Democratic senator, Warsh noted that the Fed might want to defer to the Treasury on similar issues. "In areas involving international finance, Fed officials do not enjoy the same special deference," Warsh wrote. "In these matters, the Fed will work with the administration and the Congress." This renewed cooperation between the Fed and the Treasury could extend to other areas. The United Arab Emirates has applied for its own currency swap line, a matter typically decided by the Fed. Warsh's view on deferring to the Treasury suggests he may be open to considering extending swap lines to new countries. He has also already begun working closely with Bessent. Warsh told the Senate that the two communicate frequently, beyond the regular weekly breakfast meetings between the Fed chair and Treasury secretary.
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