Summary of Key Points
On Friday, July 30th, Japan and the United States jointly intervened to buy Japanese yen. This was Japan's second major currency market intervention this year and the first time the U.S. has participated substantially in such efforts in over a decade (going beyond mere verbal support). In the short term, the yen appreciated significantly (from 163.9 to 157.57, an increase of 4%), but the market generally believes that the long-term trend of the yen will still be determined by the interest rate differential between the U.S. and Japan and arbitrage transactions. As long as Japan does not dare to raise interest rates quickly to narrow this gap, the intervention can only provide temporary relief and cannot reverse the depreciation trend. This intervention also has unique aspects (the U.S. used euros instead of dollars in its purchases), which may have side effects, such as potentially fueling speculation and undermining the credibility of the policy.
What Makes This Joint Intervention Different from Previous Ones?
The most notable aspect of this intervention is that the U.S. actually took action: previously, the U.S. would at most verbally express concern about exchange rates; this time, it directly participated by buying yen through the sale of euros, marking its first substantial involvement since 2011. Additionally, Japan did not need to sell U.S. Treasury bonds to obtain dollars (to avoid disrupting the U.S. bond market) but instead used the Federal Reserve's FIMA mechanism to temporarily exchange its bonds for dollars. The scale of this intervention was approximately 8.45 trillion yen (52.8 billion US dollars), slightly smaller than the first intervention this year (11.73 trillion yen). However, due to the U.S. involvement, the market reaction was more intense.
Comparing with past interventions, previous joint efforts were either aimed at preventing the yen from appreciating (such as in 1995) or stabilizing the exchange rate after an earthquake (in 2011). This time, the intervention was specifically aimed at curbing the excessive depreciation of the yen. Moreover, the U.S. approach (using euros instead of dollars) has raised questions about whether the U.S. still intends to maintain a strong dollar.
Short-Term Effectiveness vs. Long-Term Ineffectiveness: History Speaks Louder
Historical data shows that interventions generally have a significant short-term impact—for example, the yen appreciated by 4% within four hours of this latest intervention, and it appreciated by 3% during the first intervention in 2026. However, in the long run, these efforts are often futile. For instance, the yen continued to depreciate after previous interventions, as seen in April 2024. The reason is that interventions only provide temporary support and do not address the underlying issue: the large interest rate differential between the U.S. and Japan.
To illustrate, imagine borrowing 1 million yen (with an interest rate of 1%) and converting it into dollars to buy U.S. Treasury bonds (with an interest rate of 5%). You could earn a 4% profit annually from this arbitrage transaction. As long as the interest rate differential exists, people will continue to sell yen and buy dollars, making interventions ineffective.
Why Are Interventions Ineffective in the Long Term?
The core issue is that Japanese authorities are reluctant to take decisive action to raise interest rates. While they want the yen to appreciate, they fear the consequences of doing so, such as increased debt repayment pressures on businesses and the government (Japan's government debt accounts for 260% of its GDP) and potential harm to exports (a stronger yen makes Japanese goods more expensive). As a result, the Bank of Japan has been very cautious in raising interest rates—its latest increase was only 1%, while U.S. interest rates remain above 5%, leaving the differential unchanged.
Market analysts compare this situation to trying to stop a car without using the brakes: Japan wants a strong yen but relies on low interest rates to stimulate the economy and uses a weak exchange rate to boost exports. This contradiction undermines market confidence in the yen. As long as arbitrage transactions are profitable, the yen will continue to be sold.
The Double-Edged Nature of Interventions
While this intervention was effective in the short term, it also carries risks:
1. IMF Rules: There are restrictions on interventions, with a maximum of three within six months; otherwise, Japan could lose its status as a country with a freely floating currency, affecting its international reputation.
2. Fuelling Speculation: Interventions may reduce market vigilance, leading more speculators to bet on further yen depreciation and exacerbating price volatility.
3. Weakening Policy Credibility: Repeated ineffective interventions could lead to skepticism about the Japanese authorities' ability to control the currency.
4. The U.S. Approach’s Impact: The fact that the U.S. used euros instead of dollars raises doubts about its intentions, potentially undermining the effectiveness of the intervention.
The Future of the Yen
The key to stabilizing the yen lies in whether Japan is willing to take bold action to narrow the interest rate differential between the U.S. and Japan. This could either involve the U.S. lowering interest rates or Japan accelerating its rate hikes. However, given that inflation in the U.S. has just begun to ease, a rate cut is still unlikely in the near term, while Japan must overcome its fear of raising interest rates—perhaps by accepting short-term economic discomfort and abandoning the strategy of using a weak exchange rate to support exports.
The market is closely watching the actions of the Bank of Japan. Only if future interest rate hikes are more substantial (e.g., exceeding 1%) or if there is a clear commitment to normalize monetary policy, could the yen stop depreciating. In other cases, even more interventions may not change the overall trend.
In summary, the fate of the yen depends on whether the Bank of Japan is willing to take decisive action to raise interest rates.
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