US and Japan Intervene to Support Sliding Yen

The United States and Japan collaborated last week to intervene in currency markets, aiming to halt the significant slide of the Japanese yen. This joint action represents the first instance of currency intervention by these two nations in the Japanese yen in 15 years, signaling a notable departure from previous approaches. The intervention involved Treasury Secretary Scott Bessent selling euros, rather than the more typical sale of dollars, and utilized a less commonly known Federal Reserve repurchase agreement (repo) facility. The yen had experienced a precipitous drop in value leading up to this intervention, prompting concerns about its economic implications.

Brad Setser, a senior fellow at the Council on Foreign Relations and a frequent commentator on international finance, discussed the intricacies and potential effectiveness of this intervention on the "Odd Lots" podcast. Setser highlighted that the yen's depreciation was driven by a widening interest rate differential between Japan and other major economies, particularly the United States. As the Federal Reserve maintained higher interest rates to combat inflation, investors were incentivized to move capital out of Japan, where interest rates remained near zero, and into dollar-denominated assets. This capital outflow increased the demand for dollars and, consequently, the supply of yen in foreign exchange markets, driving down its value.

Setser elaborated on the mechanics of the intervention, noting the unusual decision to sell euros. Typically, when a country intervenes to support its currency, it sells its own currency and buys foreign currency. In this case, the US and Japan likely coordinated to sell yen and buy dollars, but the specific mention of selling euros suggests a more complex, multi-currency strategy aimed at influencing exchange rates beyond a simple bilateral swap. The use of a Federal Reserve repo facility, which allows the Fed to lend reserves to financial institutions, indicates a method for providing liquidity or facilitating the exchange of currencies without directly depleting US dollar reserves in a manner that might be perceived as a direct sale of US assets.

The effectiveness of this intervention remains a key question. Historically, currency interventions have had limited success in reversing sustained currency trends, especially when driven by fundamental economic factors like interest rate differentials. While such actions can provide temporary support and signal policy intent, they are often insufficient to counteract strong market forces without complementary policy adjustments. For the yen's slide to be permanently halted, Setser suggested that the Bank of Japan might eventually need to consider normalizing its monetary policy, which could include raising interest rates, thereby narrowing the interest rate gap with other economies. The "Odd Lots" podcast episode provided a detailed analysis of the economic backdrop, the specific actions taken, and the potential future implications for the Japanese yen and global currency markets.