The yen has been sliding for years, a dynamic driven largely by near-zero Japanese interest rates that turned the Japanese currency into the world’s cheapest source of funding. In late July, the U.S. joined Japan in a historic intervention to strengthen the yen, but it is again losing ground.
The yen traded at around 163 per dollar on July 29 before strengthening about 5% to touch 155 following the intervention on July 31. By Aug. 18, it had weakened 2.5% to around 159 per dollar. That leaves the currency close to its weakest levels of the floating era: the yen last traded near 160 per dollar in April 2024, a level it had not seen since 1990, and it is now roughly 40% below its long-run average since the mid-1980s. On a trade-weighted, inflation-adjusted basis, the yen is weaker still.
“While the intervention may have briefly changed the market narrative, the key drivers of the currency’s performance haven’t shifted,” says David Adams, head of G10 FX Strategy at Morgan Stanley Research. “Strengthening the yen requires lower U.S. interest rates and/or faster tightening by the Bank of Japan.”
Those fundamentals matter well beyond Japan. Cheap yen borrowing funds positions across global markets, and Japanese investors are among the largest holders of U.S. Treasuries—so the currency’s direction can feed through to bond yields, borrowing costs and volatility in portfolios with no direct yen exposure at all.
An Unusual Intervention
On Aug. 3, authorities from the U.S. and Japan acknowledged the coordinated intervention in currency markets and signaled that they could do it again if needed, a highly unusual way for policymakers to act and to communicate in such operations, Adams notes.
Japan’s Ministry of Finance had sold an estimated $85 billion of U.S. dollars to buy yen on July 30 and 31. The timing caught investors by surprise, with the first intervention coming one day before the Bank of Japan’s policy meeting.
The U.S., meanwhile, had sold euros to buy yen, without disclosing the amount.
“By avoiding use of the U.S. dollars, American authorities reduced the risk of raising uncomfortable questions about a change in the country’s foreign exchange policy,” Adams says.
Squeezing Speculative Yen Positions
Several factors could explain the effort to strengthen the yen, including a desire to curb market pressure for further depreciation.
For years, investors have profited by borrowing cheaply in yen and investing in higher-yielding assets elsewhere. A stronger Japanese currency makes this strategy, known as the yen carry trade, less attractive. Because that trade has become one of the largest sources of liquidity supporting global markets, an unwind can force leveraged investors to cut risk and lift volatility across equities, bonds and currencies.
“We believe the trigger and primary purpose of the intervention was to squeeze 'speculative' positions and to discourage rapid, one-way and potentially disorderly market moves,” says Koichi Sugisaki, Head of Japan Macro Strategy at Morgan Stanley Research.
The unusual participation of the U.S. could be related to the impact of higher Japan rates on the U.S. Treasury market. Japan is one of the largest holders of U.S. Treasuries. Higher Japan rates could lead Japanese investors to sell U.S. assets to repatriate capital, which could push Treasury yields higher, translating into higher borrowing costs across the U.S. economy — from mortgages and auto loans to corporate debt.
“If the volatility in the Japan rates market—which comes from the broad perception of the BoJ falling behind the curve—is helping to trigger volatility in the U.S. Treasury market, then the stabilization of Japan rates via the FX channel may have the reverse effect,” Sugisaki says. “The objective may be to buy time through intervention and bridge the market toward earlier Bank of Japan policy normalization.”
The intervention also could have been intended to demonstrate a strong commitment to defending the Japanese currency, noted Sugisaki.
Could the Bank of Japan Hike Rates Sooner?
Morgan Stanley Research economists expect the Bank of Japan to raise its policy rate from 1% currently to 1.25% in October and 1.5% in March. But the latest foreign-exchange intervention may signal the possibility of a rate increase at the next meeting in September.
“Policymakers could be more willing to accommodate a faster pace of rate hikes, particularly where higher rates align with U.S. concerns around the yen weakness, rising long-end yields and the spillover to foreign markets,” Adams says. “That said, an interest-rate increase in October is more likely than in September, as it provides a broader range of information and financial conditions to justify the move.”
The Fed Remains Key to the Yen Outlook
Morgan Stanley Research estimates the yen’s current fair value at 165 to 167 per dollar. Over time, however, that fair value is likely to strengthen to 155 per dollar, representing a gain of around 7% for the yen, as the Federal Reserve keeps rates unchanged this year and could potentially begin cutting rates next year.
That outlook underscores the limits of currency intervention: The longer-term trajectory of the yen depends primarily on the forces driving the U.S interest rate rather than the Japan interest rate, since the BoJ have been broadly recognized as “behind the curve.”
“Unless the BoJ hikes the rate above 1.75%-2% within a short period of time, markets would not likely change such perception,” Sugisaki says.
For investors, that makes each U.S. inflation print, jobs report and Fed communication a signal for the yen — and for the liquidity and Treasury demand that follow it.
“The key question remains whether the forces behind the yen weakness are starting to reverse. We think the answer is yes, but not yet,” says Seth Carpenter, Morgan Stanley Global Chief Economist and Head of Macro Research. “For the yen, the outlook depends much more on the Fed than on the intervention or the Bank of Japan.”
