Brad Setser on the US's Unusual Japanese Yen Intervention

PodcastOdd LotsBrad SetserAug 6

The discussion examines the unusual U.S.-Japan effort to slow yen depreciation, including the Treasury's reported plans, the intervention's financing, and uncertainty over its effectiveness. It also explains how Japan's rates, fiscal position, foreign-asset gains, and institutional hedging shape yen flows, while large Asian trade surpluses and currency policies affect regional markets. Brad Setser argues that intervention could work better if the BOJ raises rates and Japan repatriates foreign-asset income, though a stronger yen floor remains conditional on policy changes.

Currencies Monetary Policy Interest Rates

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Key Takeaways

U.S.-Japan intervention to support the yen reportedly involved a planned $5 billion to $10 billion yen purchase, euro sales, and use of the Federal Reserve's Foreign Monetary Authorities Repo Facility. The facility, capped at roughly $60 billion and priced at a premium, lets Japan obtain dollars against Treasury collateral without immediately selling Treasuries, but markets remain uncertain about the intervention's scale and ability to halt yen weakness.

The yen remains exceptionally weak near 160 per dollar despite Japan's current-account surplus of roughly 5% of GDP, large foreign-asset holdings, and improving primary balance. The episode attributes the weakness mainly to Japan's very low-rate environment and argues that intervention would become more effective if the BOJ raised rates while oil prices remained supportive.

Japan's currency weakness reflects both positive-carry yen shorts and substantial institutional hedging flows: dollar yields exceeded yen yields, while rising Nikkei exposure encouraged foreign investors to hedge and Japanese institutions reduced hedge ratios. Because expectations of continued depreciation have suppressed hedging, a shift in those expectations could generate yen support, increasing the risk for short-yen positions after the Ministry of Finance's intervention threshold was tested around 160 to 162.

Japan's foreign-exchange reserves could serve as a fiscal as well as currency-management tool: selling dollars acquired near 80 to 100 yen per dollar at around 160 could generate gains that materially reduce gross debt. Repatriating part of the government's roughly $35 billion to $40 billion in annual foreign-asset interest income was also identified as a way to alter yen flows and help establish a currency floor.

GEO-POLITICS

Yen Intervention — Scott Bessent's photographed Treasury to-do list reportedly called for buying $5 billion to $10 billion of Japanese yen. The United States and Japan subsequently intervened to slow yen depreciation, with the United States selling euros and using a Federal Reserve repo facility. The intervention's volume and ability to halt further weakness remained uncertain.

“And he put in the JPY. Yeah. So it was no no ambiguity. 5 to 10,000,000,000. Yeah…”—

ECONOMY

BOJ Inflation Reset — The Bank of Japan has been slow to raise rates because policymakers want to avoid prematurely interrupting inflation's return toward its 2% objective. Higher rates could also raise funding costs for banks holding low-yielding assets and increase the government's interest burden.

“For whatever reason, the Bank of Japan has been very slow to raise rates. So the short term policy rate is about 1 well, it is 1%…”—

Foreign Repo Facility — The Foreign Monetary Authorities Repo Facility lets foreign central banks obtain dollars against Treasury collateral instead of immediately selling Treasuries. It carries a premium and is capped at roughly $60 billion, but it can give a ministry of finance flexibility to fund intervention and delay Treasury sales. Removing the cap would make the facility unlimited in quantity in theory.

“It's called the foreign Monetary Authorities Repo Facility, very catchy, or FEMA. And it basically allows foreign central banks to use their treasuries as collateral to get dollars.”—

Japan Debt Dynamics — Japan's primary balance is now roughly flat and trending toward a surplus, making its fiscal position stronger than that of several other G7 economies on this measure. Debt dynamics remain manageable if nominal rates rise alongside inflation and nominal growth. The key risk is a sharp rise in nominal rates without corresponding inflation.

“It's now flat. There's no primary deficit…”—

MARKETS

Asian Trade Surpluses — East Asia is running exceptionally large trade surpluses. Korea's current-account surplus is expected to rise from just over $100 billion to between $300 billion and $400 billion, while Taiwan's surplus is also expected to increase substantially.

“So we have really record trade surpluses throughout East Asia, except for Japan. We'll get to Japan a little bit later…”—

Taiwan Currency Policy — Taiwan's central bank has engineered a weaker Taiwan dollar by reversing prudential regulations and allowing life insurers to leave more foreign assets unhedged. The strategy is also linked to conversion decisions by TSMC.

“With Taiwan, it's a bit different. The central bank doesn't want its currency to strengthen…”—

Korean Equity Flows — South Korea exhibits a feedback mechanism in which stronger equities can coincide with a weaker won. Foreign investors sell Korean stocks after reaching concentration limits, while pension-system outflows add currency pressure. Leveraged single-stock ETFs provide another source of instability for Korean investors.

“Korea is different. Korea has been strange…”—

FORECASTS

Potential Yen Target — If Japan's pension-fund operating guidance changed so that it hedged its roughly $950 billion foreign portfolio, the Treasury and Japan's Ministry of Finance could potentially provide enough collective firepower to defend a dollar-yen level around 150, or more likely 160. The speaker presents this as a conceptual possibility, not a settled policy decision.

“Now you can argue that between the treasury, the MOF, if Japan could, through some magic, change some of the pension funds operating guidance so that it started hedging its…”—

Yen Intervention Setup

The hosts introduce Treasury Secretary Scott Bessent's yen-buying memo, Japan's sharp currency weakness, and the unusual US-Japan intervention.

Why Japan Delays Rate Hikes

Brad Setser explains why the BOJ has been cautious about raising rates, citing inflation credibility, bank funding costs, and concerns about government interest expenses.

Asian Currency Weakness

Setser links weak Asian currencies to enormous trade surpluses, central-bank policies, pension outflows, equity hedging, and unusual flows from Korea and Taiwan.

Yen Flows And Speculation

The discussion distinguishes modest hedge-fund carry trades from larger real-money hedging flows involving Japanese institutions, foreign equities, and the GPIF.

US Case For Intervention

Setser describes concerns about Asian currency undervaluation, pressure on American manufacturers, and Treasury-market risks if Japan funds intervention by selling Treasuries.

Currency Fair Value Models

Traditional purchasing-power and equilibrium-exchange-rate models remain useful analytically, but financial flows have pushed Asian currencies far from fundamental valuations.

FEMA Repo Facility

Setser defends the Fed's foreign-authority repo facility as a way for Japan to obtain dollars without immediately selling Treasuries into a stressed market.

Defending The Yen Floor

The speakers examine whether Treasury can establish a yen line in the sand, concluding that credible defense depends on Japan's reserves, pension assets, and policy coordination.

Will Intervention Work?

Setser argues intervention can work if the BOJ raises rates, the yen has overshot fundamentals, and Japanese institutions change hedging and repatriation behavior.

Japan Fiscal Position

Japan's primary balance, foreign-asset income, and falling net debt make its fiscal outlook less fragile than commonly assumed, especially compared with the United States.