Contrary to economic fundamentals, East Asian currencies are weak. This paradox is driven by complex financial flows, including foreign investors hitting concentration limits in booming stock markets and pension fund outflows, which are currently overriding strong trade balances.
The US Treasury's intervention was not just about the Yen's exchange rate or trade balance. A primary motive was to prevent Japan from being forced to sell its vast US Treasury reserves to fund its own intervention, which could create significant pressure on the US bond market.
The little-known FEMA repo facility allows foreign central banks to post US Treasuries as collateral to get dollars. This lets countries like Japan intervene in FX markets without fire-selling their bond holdings, thus mitigating stress on the US Treasury market.
Despite a high headline debt-to-GDP ratio, Japan's primary fiscal balance (excluding interest payments) is now balanced. This makes its fiscal position fundamentally stronger than that of the US, challenging the popular theory that fiscal weakness will inevitably crash the yen.
The US-Japan yen intervention wasn't about establishing an unbreakable price cap. Instead, its primary goal was psychological: to make speculators nervous about shorting the yen near the 160 JPY/USD level, thereby restoring the Ministry of Finance's perceived threat.
Japan's government, via its pension fund (GPIF) and reserves, is a massive holder of foreign assets. Unlike private firms, it typically does not repatriate the enormous interest and dividend income. This structural feature removes a major source of natural buying pressure for the yen.
The BOJ's reluctance to raise short-term rates isn't just about inflation psychology. A key technical concern is that hiking rates would immediately increase funding costs for Japanese banks on deposits, while their balance sheets are filled with long-term, low-yielding assets, creating a painful margin squeeze.
In a highly unusual move, the US sold its euro reserves—not US dollars—to intervene in the yen market. This was a tactical decision to frame the action as a specific judgment on yen over-depreciation, rather than a broader statement on the strength of the dollar.