Half of Gains Erased! Yen Nears 160 Against USD Again, Will Japan and U.S. Intervene Jointly?

On August 10, the yen fell 1%, erasing half of the gains brought by the first Japan-U.S. joint intervention since 1998.

After the joint intervention on July 31, the yen against the U.S. dollar once approached 155, but has now fallen below 159 again. The market is currently focusing on the 160 level, the next moves of the Bank of Japan and the Federal Reserve, and whether Japan will use the Federal Reserve's Foreign and International Monetary Authorities (FIMA) Repo Facility.

Approaching 160 Again

In the previous joint intervention, U.S. Treasury Secretary Bessent said, "We will do whatever it takes to support them (Japan) to help the U.S. economy, U.S. taxpayers, and stabilize the global economy."

Market participants had previously analyzed that Bessent's main motivation for supporting the joint intervention in the yen was likely to stabilize the U.S. Treasury market.

Kinoshita Tomofumi, Japan global market strategist at Invesco, told reporters that at the end of July, the U.S. dollar against the yen exchange rate approached 164. "Japanese authorities may worry that yen depreciation will further push up inflation, while U.S. authorities may worry that a stronger dollar will weaken U.S. export competitiveness and cause turmoil in Japan's financial market, including rising long-term Japanese government bond yields, which could spill over and push up U.S. long-term Treasury yields. Therefore, Japan and the United States have chosen to strengthen coordination to deal with yen weakness."

However, just a few days after the joint intervention, the yen is approaching the 160 level again. Market participants believe that Bessent's suggestion of unlimited support to save the yen may backfire, raising doubts about how much firepower he can actually deploy and making the market doubt the effectiveness of the joint intervention. In terms of foreign exchange intervention ammunition, Bessent is obviously limited by his main special tool—the Exchange Stabilization Fund, which holds less than $220 billion in assets. Accordingly, according to media estimates, Japan alone spent $53 billion to intervene in the yen exchange rate on July 30, the day before the Japan-U.S. joint intervention.

Nathan W. Thooft, senior portfolio manager at Manulife Investment Management, said, "The United States can influence market sentiment through joint intervention with Japan, but it cannot change the fundamental facts. U.S. authorities have deep pockets, but they are not unlimited."

This is also related to the fact that the Federal Reserve has not substantially intervened. In theory, the Fed can print dollars, so it at least theoretically has unlimited "ammunition" to intervene in the foreign exchange market to suppress the dollar. However, in this joint intervention, the Fed's role is temporarily limited to actually executing yen purchase operations on behalf of the U.S. Treasury. Historically, the Fed sometimes used its own funds to intervene jointly with the U.S. Treasury to show support for intervention measures. For example, in the 1998 yen intervention operation, the Fed and the U.S. Treasury each contributed 50%. In the 2000 joint purchase of euros and the 2011 joint sale of yen intervention operations, the Fed also allocated intervention funds equally with the U.S. Treasury.

The market is closely watching the key 160 level. Once the yen against the U.S. dollar breaks below the key psychological level of 160, whether Japan intervenes alone or the United States and Japan jointly intervene again, the pressure to intervene may increase.

In the latest report, Marco Casiraghi, strategist at Evercore ISI, wrote that if the United States and Japan allow the yen to continue trading above 160, the market may interpret the lack of intervention as a signal that the United States is unwilling to sell dollars. This could attract additional market pressure and test both sides' commitment to supporting yen strength.

What Next for the Fed and Bank of Japan?

In addition to paying attention to whether the United States and Japan will intervene in the foreign exchange market again, since the root cause of yen weakness lies in the Japan-U.S. interest rate differential and the resulting yen carry trade, the market is also closely watching the policy choices of the Federal Reserve and the Bank of Japan.

Kinoshita Tomofumi told reporters that the subsequent policies of the Bank of Japan and the Federal Reserve may be favorable to yen strengthening. He said that the Bank of Japan sent a more hawkish signal than before at its monetary policy meeting at the end of July. In the latest Economic and Price Outlook report, the Bank of Japan emphasized that core inflation may exceed its 2% target and negatively affect economic activity. In addition, Bank of Japan Governor Ueda Kazuo said at the post-meeting press conference that "the pace of rate hikes may accelerate," suggesting that the future pace of rate hikes may no longer maintain the previous rhythm of about once every six months, but adopt a faster pace of rate hikes. These statements may further strengthen the effect of this round of foreign exchange intervention.

Before this foreign exchange intervention operation, a large number of speculative yen short positions had accumulated in the financial market. If market concerns about another joint Japan-U.S. intervention further intensify, these positions may be forced to close, further pushing up the yen.

At the same time, he added, the U.S. willingness to participate in coordinated intervention to support the yen this time, in addition to reflecting its concerns about yen depreciation, also shows that it may welcome the Bank of Japan adopting tighter monetary policy. If the Japanese government weakens its constraints on the Bank of Japan's rate hikes due to U.S. influence, the Bank of Japan may face an environment more conducive to further tightening monetary policy in the future. Based on recent latest developments, it is expected that the Bank of Japan's next rate hike will be advanced from the previously predicted December to October.

Financial markets are also gradually digesting the possibility of the Bank of Japan raising rates ahead of schedule, which seems to provide some upward momentum for the yen. In addition, the possibility of the Federal Reserve raising rates further this year is low, which means that the Bank of Japan's continued rate hikes will help narrow the Japan-U.S. interest rate differential and provide support for the yen.

The UBS Chief Investment Office wrote in its latest view to reporters that the direction of the Federal Reserve is the key to the yen exchange rate. In UBS's view, unless there is a major shift in Bank of Japan policy, including faster rate hikes and a terminal policy rate higher than currently expected, it will not be able to sustainably push the yen back up. This makes the Federal Reserve the key factor affecting the U.S. dollar against the yen exchange rate, and therefore adds uncertainty to the outlook.