The effectiveness of the joint U.S.-Japan intervention is fading, with the yen returning to the 159 level and testing policy limits

Original Author: Bao Yilong

Original Source: Wall Street News

The effectiveness of the joint U.S.-Japan intervention is fading, with interest-rate differential-driven carry trades once again pushing the yen back to the 159 level.

On August 12, the yen fell 0.1% to touch 159.39 before closing roughly flat, but the currency's continued depreciation in recent weeks has erased about half of the gains from the joint U.S.-Japan intervention.

As Wall Street News noted, on July 31, the U.S. Treasury, through the New York Fed, commissioned Goldman Sachs and Morgan Stanley to sell euros and buy yen — marking the first direct U.S. participation in yen intervention in nearly 30 years.

That intervention lifted the yen from around 163 to 155, a historic move in which Washington and Tokyo jointly bought yen, with both sides subsequently signaling that further measures could be taken if necessary.

However, persistently elevated U.S. Treasury yields, coupled with rising international oil prices, have added pressure on Japan as a net energy importer, bolstering dollar bulls and causing the yen's gains to quickly evaporate.

Market attention is now turning to the Bank of Japan, whose next monetary policy meeting is scheduled for September. Many strategists believe that unless the BoJ moves more aggressively toward policy normalization, the impact of intervention will remain extremely limited. The 160 level has come to be viewed as the authorities' political red line — should the exchange rate rapidly approach that threshold, a new round of intervention could be triggered at any time.

Yield Differentials Persist, Carry Trades Dominate Exchange Rate Direction

At the core of this intervention's failure lies the widening interest rate gap between the U.S. and Japan.

The 10-year U.S. Treasury yield currently stands at 4.686%, while the same-maturity Japanese government bond yield is just 2.846% — a spread of more than 180 basis points that provides investors with a powerful incentive to borrow low-yielding yen and rotate into higher-yielding dollar assets.

Jesper Koll, expert director at Monex Group, commented:

Intervention frightened the market, but it cannot stop the laws of finance from operating — capital always flows toward the highest returns. As long as Japan's cost of funding remains below overseas returns, carry trades will make a comeback.

Masahiko Loo, FX strategist at State Street Global Advisors, argues that intervention is not without value, but its significance lies more in curbing excessive speculation than in altering fundamentals. He said:

Intervention successfully reset market psychology and demonstrated an extraordinary degree of policy coordination between the U.S. and Japan, but it has not yet eliminated the yield advantage supporting the dollar. A more accurate understanding is this: intervention has been effective in slowing speculation, but it has not yet worked in changing fundamentals.

Intervention More Like a Guardrail, 160 Is the Authorities' Political Red Line

Until the aforementioned structural contradictions are resolved, the market's characterization of intervention is shifting — its role may not be to reverse the yen's decline, but rather to prevent the decline from accelerating into a disorderly rout.

State Street's Loo noted that the 160 level has become the "authorities' political red line," and if the exchange rate again rapidly approaches that level, the probability of officials returning to the market would rise significantly. He stated:

I would not rule out another intervention, especially in the case of rapid or disorderly market moves. But at the end of the day, intervention can only buy time — the real heavy lifting still rests on policy normalization by the Bank of Japan, potentially as early as September.

To enhance the deterrent effect of intervention, both Washington and Tokyo have also been actively promoting the Federal Reserve's Foreign and International Monetary Authorities (FIMA) repo facility.

This facility would allow Japan to obtain dollar liquidity using U.S. Treasuries as collateral, thereby reducing its need to sell U.S. debt to fund intervention. Treasury Secretary Scott Bessent has signaled support for expanding this mechanism.

Bank of Japan Becomes the Key Variable — Rate Hikes Alone May Not Suffice

Against the backdrop of Japanese interest rates being unlikely to rise rapidly and no near-term signs of U.S. yields declining, investors still have ample incentive to allocate capital overseas.

John Wood, Chief Investment Officer for Asia at Lombard Odier, said the latest round of intervention had a "limited shelf life," and the Bank of Japan may need at least two rate hikes to truly draw a line under the yen's persistent weakness.

Monex's Koll noted that what shocks investors more than the intervention itself is the BoJ's reluctance to tighten policy more aggressively, raising questions about whether concerns over Japan's banking system or its massive public debt burden are constraining policymakers.

Crédit Agricole Corporate and Investment Bank believes the deeper root of the yen's weakness lies in the "asymmetry of investment capacity" between the U.S. and Japan. The United States' large-scale investment in artificial intelligence and other fields continues to attract global capital, while the public-private partnership investment plan outlined by Japanese Prime Minister Takaichi Sanae has yet to be fully implemented.

The institution stated:

What is needed to correct the yen's weakness is not higher interest rates, but greater investment.

This means that for the yen to achieve a sustainable rebound, it fundamentally depends on enhancing the attractiveness of Japanese assets themselves, encouraging domestic savings to stay at home rather than continuing to chase overseas returns.