The US joins Japan to intervene on the yen: selling euros, not dollars, and betting the BOJ hikes
In a rare move, the US Treasury has intervened on the yen alongside Japan, selling euros rather than dollars and putting the FIMA repo facility to use. Brad Setser argues the intervention will work as long as the Bank of Japan raises rates, and that Japan's fiscal position is far better than America's.
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The argument · tap a timestamp to hear it
What the BOJ fears is not inflation but the return of deflation
The Bank of Japan has raised rates slowly: the short-term policy rate is around 1%, while inflation has long since run above that level. Its reservations include not wanting to end prematurely the 2% inflation target it worked so hard to reach, and not wanting to fall back into a zero-rate deflationary economy. Technically, higher rates push up banks' deposit costs while banks hold large amounts of low-yielding assets, which could hit the banking system. Beyond that, one view in the market is that hikes would raise the government's funding costs, though Brad thinks that worry is somewhat overstated.
— Brad SetserEast Asia is piling up the world's surpluses, and its currencies keep weakening
The world's trade surpluses are concentrated in East Asia. Korea's current account surplus is set to go from a hundred billion dollars to three or four hundred billion, and Taiwan's surplus will reach 25%-30% of GDP — yet the currencies are broadly weaker. Taiwan's central bank has guided the New Taiwan dollar down by loosening regulation. In Korea, a rising stock market tripped foreign-investor concentration limits, so foreign investors sold Korean equities and money flowed out; layered on top of pension outflows, it creates a perverse loop in which good news turns into bad news. Yen weakness, by contrast, comes more from extremely low interest rates.
— Brad SetserThe US is rescuing the yen; what it really wants to rescue is Treasuries
Traditionally, weak East Asian currencies hurt American manufacturing, autos above all, but Bessent has not emphasized that. What he is focused on is the pressure a weak yen puts on the whole Asian currency system, and the hit it could deliver to the Treasury market. If the Bank of Japan intervened by selling Treasuries, that would compound the pressure on Treasuries. Joint intervention by the US both supports the yen and reduces Japan's need to sell Treasuries, which protects the Treasury market.
— Brad SetserSelling euros rather than dollars says this is not about the dollar
Part of why the US sold euros instead of dollars is that Bessent, a former FX trader, wanted to ‘have some fun’. But the more important signal is this: the operation is not a view on the dollar's exchange rate, it is aimed purely at the yen. By selling euros, the US shows it still backs a strong dollar while avoiding the misreading that a direct dollar sale would invite. It also makes the operation more flexible — running a rate check in the euro-yen market, for instance, to create an element of surprise.
— Brad SetserJapan should pledge Treasuries rather than dump them, but the line is too small
The FIMA repo facility lets foreign central banks pledge Treasuries to obtain dollars from the Fed, avoiding outright Treasury sales. Brad was one of the people who pushed for the facility, and he thinks it can keep the Treasury market from spiralling into a fire sale in periods of stress. But it prices above the market and is capped at around $60 billion, which may limit how effective it is. Even so, for Japan's Ministry of Finance, which holds old high-coupon bonds, using FIMA may be a better deal than selling, because it keeps the bonds and earns the spread.
— Brad SetserAmerica's intervention ammunition cannot support an exchange-rate target
The US Treasury's own ammunition is limited: the Exchange Stabilization Fund (ESF) holds roughly $20 billion of foreign currency and $20 billion of cash, plus around $160-170 billion in Special Drawing Rights (SDRs) — substantial, but not unlimited. Setting a target level for the yen would require cooperation from Japan's Ministry of Finance and institutions such as GPIF, for instance by changing pension investment guidelines so they hedge their FX risk. But setting a fixed target is very risky: once the world changes — an oil shock, a Fed rate hike — you may be forced to abandon it.
— Brad SetserWhether the intervention works comes down to a September rate hike
Brad's view is that if the Bank of Japan raises rates in September, the intervention will work; if not, it will face a test. He pushes back on Adam Posen's argument that intervention does not work, pointing out that the yen is deeply oversold and the fundamentals are improving: oil is not expensive, Japan's current account surplus is 5% of GDP, and the long-term interest rate gap has already narrowed. The key is changing market expectations — and because the Japanese government is the largest holder of foreign exchange assets, what it does has an outsized effect on the currency.
— Brad SetserShorting the yen is a long position in the worse fiscal story
Japan's fiscal position is far better than the market believes: the primary balance, which excludes interest, is already in balance and even trending toward surplus, better than the US, the UK, France and Germany. Rising rates do add to the interest burden, but the Japanese government holds an enormous stock of overseas assets whose returns offset part of that cost. Net debt has been falling for five years running, while US net debt will soon catch up. Brad's argument is that being short the yen and long the dollar is in effect a long position in US public finances — and US public finances are in worse shape.
— Brad SetserIn their own words · checked verbatim
I think it will be enough if the Bank of Japan is going to raise rates and maybe raise rates several times. I think the only reason why it wouldn't be enough if the Bank of Japan is going to raise rates.
Brad Setser26:33
Just always remember Japan is selling dollars at by between eighty and one hundred depending on when they bought it, and somewhere around one sixty. This and the worst you can say this operation. It reduces gross debt in a really big way.
Brad Setser37:45
Figures
| BOJ short-term policy rate | about 1% | 4:06 |
| Taiwan current account surplus as a share of GDP | 25%-30% | 7:13 |
| Japan current account surplus as a share of GDP | 5% | 9:17 |
| Japan's foreign exchange reserves | about $1.2 trillion | 9:17 |
| Japanese government pension foreign assets | over $900 billion | 9:17 |
| Japan's GDP | about $4 trillion | 9:17 |
| FIMA repo facility cap | about $60 billion | 19:29 |
| US Exchange Stabilization Fund (ESF) foreign currency assets | about $20 billion | 23:30 |
Glossary
- FIMA Repo Facility
- The Fed lets foreign central banks pledge Treasuries to obtain dollars, avoiding outright Treasury sales.
- ESF (Exchange Stabilization Fund)
- The US Treasury's pool of money for foreign exchange intervention; limited in size.
- Primary Balance
- Government revenue minus spending excluding interest; a gauge of fiscal health.
- Carry Trade
- Borrowing a low-rate currency such as the yen to invest in higher-yielding assets and pocket the spread.
- Big Mac Index
- Compares purchasing power parity using McDonald's Big Mac prices, as a measure of currency valuation.
How to listen
Investors who follow currency markets and Treasuries, macro strategists, central bank watchers, and anyone studying Japan's economy and fiscal policy.
The two hosts' closing chat (after roughly 38:47) can be skipped.