Summary of Key Points
After the first joint intervention by the US and Japan to stabilize the yen exchange rate at the end of July, the yen briefly rebounded, but it fell back to its previous level within just over a week—on August 10th, the yen depreciated by 1%, erasing half of the gains from the intervention and once again approaching the 160-level. There are three main concerns in the market right now: 1) Whether the yen will fall below 160 and whether the US and Japan will intervene again; 2) Whether the policies of the Bank of Japan (BOJ) and the Federal Reserve (Fed) will change (for example, if Japan raises interest rates or the Fed stops raising them); 3) Whether Japan will use the Fed’s FIMA tool to support the yen.
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Detailed Analysis
Why the Joint Intervention Was Ineffective?
Despite the apparent momentum behind this joint intervention by the US and Japan, its impact was limited:
- Lack of funds from the US: The US’ Foreign Exchange Stability Fund, which is used for such interventions, has less than $220 billion, while Japan alone spent $53 billion just before the intervention. This made investors skeptical about the US’s ability to sustain the support for the yen.
- The Fed Didn’t Contribute Funds: Historically, during joint interventions, the Fed and the Treasury Department have each contributed half of the funds. However, this time the Fed only assisted with the operational aspects without contributing any money itself. This led the market to believe that the US was not truly committed to doing everything necessary, which resulted in the yen falling back quickly.
- Doubts About the “No Upper Limit” Claim: Although the US Treasury Secretary stated that they would do whatever it took, the reality of their financial resources cast doubt on the effectiveness of the intervention.
The 160-Level: A Critical Threshold for the Yen?
The number 160 is not just a random figure; it represents a psychological barrier in the market:
- Further Selling Could Occur: If the yen falls below 160, investors may assume that the US and Japan are no longer interested in stabilizing the exchange rate, leading to even more aggressive selling and a sharper decline.
- Increased Interventions Would Be Necessary: If the yen breaks through 160, Japan would either have to intervene on its own (at a greater cost) or seek another joint intervention with the US (which the US might be reluctant to do). The market will continuously test the resolve of both countries to maintain stability.
The Root Cause of the Yen’s Weakness: The Large Interest Rate Gap
The main reason for the yen’s weakness is the significant difference in interest rates between the US and Japan:
- Arbitrage Transactions: Japanese individuals or international investors exchange yen for dollars and deposit them in US banks to earn higher interest rates, leading to an increase in the supply of yen and a corresponding decline in its value.
- Central Bank Policies Are Crucial:
- BOJ: The BOJ has recently hinted that it might accelerate interest rate hikes (from once every six months to possibly as early as October). If this happens, higher Japanese interest rates would narrow the interest rate gap and help stabilize the yen.
- Fed: The likelihood of another interest rate hike by the Fed this year is low. If US interest rates remain unchanged, a rise in Japanese interest rates could further narrow the gap and support the yen.
The FIMA Tool: A Temporary Solution?
FIMA (Foreign Exchange Market Intervention Account) is a tool provided by the Fed for foreign central banks to borrow funds in emergencies. If Japan uses this tool, it would not have to directly sell US Treasury bonds to obtain dollars but could use its own bonds as collateral. However, there are two major issues:
- Limited Capacity: The maximum loan amount is $60 billion per day, which is only enough for a single day of intervention and cannot be used on a long-term basis.
- High Cost: The interest rate on these loans is 3.75%, which is higher than regular financing options. Long-term borrowing could actually make the market perceive Japan as less confident in its ability to stabilize the yen, potentially encouraging more selling.
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In Conclusion
Whether the yen can be stabilized depends on two key factors: whether the US and Japan are willing to make significant efforts to intervene, and whether the central banks of both countries can reduce the interest rate gap. If Japan indeed raises interest rates ahead of schedule and the Fed stops raising rates, the yen might gradually recover. However, if the yen falls below 160, market panic could lead to more intense fluctuations.
(The entire analysis is written in plain language to make it understandable even for those outside the financial industry.)