From Daleep Singh, Vice Chair & Chief Global Economist, PGIM
Backdrop:
This was the first US-Japan joint intervention in JPY since Fukushima in 2011. Japan had been intervening solo to stabilize the yen in April and May by a record amount. Reported estimates are that the Ministry of Finance sold another $40-60bn USDs to buy yen on July 30, which was then followed by $5-10bn of yen buying from the US on July 31 (this is a massive amount for the UST as well; for context, the UST intervention in 2011 was on the order of $1 billion).
Why?
One might say geopolitical solidarity. A signal of friendship. But to me, there’s no doubt it’s mostly about protecting the Treasury market at a moment of fragility. Japan is by far the largest foreign holder of Treasuries with over a trillion USD in Treasury holdings. Some believe Japan was poised to sell longer duration USTs after depleting its dollar cash and deposits being held at the Fed.
Why did the US Treasury intervene by selling euros and not dollars?
First, because Treasury’s Exchange Stabilization Fund mostly holds euro and Japanese T-bill equivalents. Second, optics. It’s unlikely the US Administration is excited by the idea of selling USDs to defend a foreign currency. Third, the Treasury and Fed have historically sterilized FX interventions, which means the Fed conducts open market operations in the aftermath of FX interventions to leave the domestic money supply unchanged. By selling euros, the need to sterilize is sidestepped (for now).
Will it work?
I’m not convinced it will. The fundamentals here are forward interest rate differentials. Normally an FX intervention to strengthen a currency works if the central bank is adjusting rate policy to reinforce the direction of the intervention. In this case, it would require the Bank of Japan to hike in tandem with buying yen. That’s not happening, at least not yet. And meanwhile, the Fed may very well hike rates as soon as next month (our forecast), which will push interest rate differentials against the yen once more. So yes, the intervention is no doubt squeezing out short yen positions in the short term, but I’m skeptical that it will work in reversing the JPY weakness trend by itself…and it may backfire spectacularly.
To put a fine point on this:
If the intervention doesn’t work, the spillover effects in the Treasury long end, and potentially Fed policy, would be significant. Not because Japan dumps dollar assets in a fire sale – I’d say that’s a remote risk – but because speculators might amplify the reversal by aggressively selling yen and USTs together to force the BoJ and Fed into precautionary rate hikes.
What could be done to expand the Fed’s FIMA repo facility?
To level set, this is the facility the NY Fed introduced in 2020 to allow foreign central banks to temporarily swap their UST holdings for US dollars. The purpose is to reduce outright sales of USTs by large holders during market stress.
So, what could be done to expand it?
The most important step would be to uncap the $60bn limit per counterparty. Other adjustments would be of second-order importance but could include expanding the term of the repo to 7d or 30d, expanding collateral eligibility, lowering the cost, reducing the haircuts, etc. All of these changes require a majority vote by the FOMC. And all else equal, enhancing the FIMA backstop would be a positive signal for the UST market. But don’t get it confused – it’s a shock absorber, not a cure for currency trends driven by fundamentals.
