Summary of Key Points
The United States and Japan have recently jointly intervened in the Japanese yen exchange rate. The U.S. Treasury Department has purchased yen by selling euros rather than the traditional dollar, a move that has raised questions in the market. While such short-term intervention may curb the depreciation of the yen, there is widespread skepticism about its long-term effectiveness. The fundamental reasons for the yen's weakness include Japan's deflationary trends, demographic challenges, and the central bank's contradictory policies—on one hand, it may raise interest rates, but on the other hand, it continues to buy bonds to suppress interest rates. Additionally, certain factors could lead to a significant appreciation of the yen, potentially triggering the liquidation of yen arbitrage transactions worth over $1 trillion, which could impact global markets, especially high-liquidity assets such as U.S. tech stocks. The current exchange rate of the dollar against the yen is near the critical support level of 155; breaking through this level would require an intervention on a much larger scale than in the past, posing a greater risk of market volatility.
I. The "Abnormal" Nature of This Intervention: Selling Euros to Buy Yen
Traditionally, when the U.S. and Japan jointly intervene in the yen, the U.S. would use dollars to buy yen. However, this time they are selling euros. The market immediately wondered whether the U.S. still intends to maintain a strong dollar or is concerned about Japanese purchases of U.S. bonds affecting their prices. Bennett explained that it was merely an adjustment of foreign exchange reserves and that the euro was already at a reasonable level. Experts, however, disagree with this rationale. For instance, Brooks from the Peterson Institute believes that such a strategy weakens the effectiveness of the intervention, as it suggests the U.S. is not committed to supporting the yen and may even be indirectly protecting U.S. bonds from being sold by Japan, which further undermines confidence in the yen.
II. Intervention Can Only Provide Temporary Relief; Japan's Fundamental Issues Remain Unresolved
Even Bennett acknowledges that buying yen can only stabilize market fluctuations in the short term; long-term solutions depend on Japan making policy adjustments. Japan faces several persistent problems:
- Long-standing Economic Issues: Years of deflation, weak domestic demand, and an aging population are not issues that can be resolved by intervention.
- Policy Contradictions: The Bank of Japan has indicated a possible interest rate hike (to strengthen the yen) while still purchasing 2.5 trillion yen in government bonds each month to suppress long-term interest rates, thereby weakening the yen.
- Historical Lessons: Last year, when the U.S. helped Argentina with its peso intervention, the depreciation was temporarily halted, but the peso later returned to its previous level—without fundamental policy changes, such interventions are merely temporary solutions.
Experts argue that Japan must normalize its monetary policy and stop relying on ultra-low interest rates. Otherwise, investors will continue to use the yen for arbitrage (buying high-yield assets with cheap yen), leading to further weakening of the yen.
III. Yen Arbitrage Transactions: A "Time Bomb" for Global Markets
Yen arbitrage transactions involve borrowing yen at near-zero interest rates to buy high-yield assets such as U.S. tech stocks or Mexican pesos, profiting from the interest rate difference. If the yen suddenly appreciates, the cost of borrowing yen increases, forcing investors to sell their high-yield assets and convert them back into yen to repay the loan. This could lead to:
- Asset Price Crashes: In 2024, a sudden appreciation of the yen caused global markets to plummet due to arbitrage liquidations.
- Massive Scale: HSBC estimates that the total amount of yen arbitrage transactions exceeds $1 trillion. If these transactions are liquidated, highly liquid U.S. tech stocks would be among the first to be sold, triggering a wave of deleveraging in the overall stock market as investors sell assets to repay their loans.
For example, a manager at StoneX stated, "When the yen strengthens, tech giants become easy targets for selling; such movements can quickly spread from Japanese exchange rate fluctuations to a sharp decline in U.S. stocks."
IV. The 155 Level: A Critical Threshold for the Yen Exchange Rate
The exchange rate of the dollar against the yen at 155 is a key threshold:
- Past Support: During interventions in April and May this year, 155 served as a bottom; since it has not been broken through, the market views it as a safe level.
- Breaking Through Requires Major Action: The current exchange rate is near 157, so breaking through this level would require a much larger intervention effort.
- Risks of Breaking Through: If 155 is indeed breached, the yen could continue to appreciate, but it could also trigger arbitrage liquidations, posing a double-edged sword for global markets: while the yen might stabilize, asset markets could suffer.
Conclusion
The U.S.-Japan intervention in the yen is a temporary measure that does not address the underlying issues. For the yen to become truly stable, Japan must address its economic problems and adjust its contradictory monetary policies. Global investors, meanwhile, should be vigilant of the 155 level, as breaking through it could lead to significant market volatility due to arbitrage liquidations.