Picture This: US-Japan Yen intervention signals growing concern over global financial stability

 On July 31, the US and Japanese authorities jointly intervened to support the yen – the first joint US-Japan intervention of this type since 1998.

The intervention injected some two-way risk into the market and, initially, had some success. From a low of 164 vs the US dollar, a four-decade low, the yen rose to 156 by August 3.    

From Japan’s side:

• Currency weakness was exacerbating already strong inflationary pressures - import price inflation was close to 30% in June.
• Concerns about inflation were aggravating strong upward pressure on JGB yields – the 30-year yield of around 4% is a record high and the 10-year yield of close to 3% is the highest since the late 1990s.

From the US side:

• Dollar strength against a key trading partner runs counter to a key US administration objective of rejuvenating its manufacturing sector.
• Excessive yen weakness could lead to competitive devaluations and broader currency depreciation across Asia.
• It risks adding to upward pressure on US Treasury yields

The effects of the intervention have started to fade, with the yen slipping back towards 160 on August 12. While currency interventions buy time, to have a lasting effect they need to align with the fundamental drivers of exchange rates.  

The fundamental drivers of yen weakness include:

• Concerns over inflation and whether the Bank of Japan (BoJ) is not raising policy rates quickly enough to contain it.
• Uncertainty related to the Japanese government’s fiscal plans.

More intervention is possible, but as the concerns above are likely to persist, it may not work. The BoJ could end up hiking rates more quickly, adding to upward pressure on JGB yields.

In turn, this may encourage Japanese investors to switch out of Treasurys, adding to upward pressure on US yields. Official Japanese selling of Treasurys would have the same effect.  

• Japan has the largest foreign holdings of US Treasurys, at US$1.1 trillion as of May (12% of total foreign holdings).

To try to contain these risks, Japan has been given access to the US Foreign and International Monetary Authorities Repo Facility (FIMA) - a temporary backstop of dollar liquidity. Its daily usage is currently capped at US$60 billion.

This article was published by S&P Global Market Intelligence and not by S&P Global Ratings, which is a separately managed division of S&P Global.