ROI-Yen bears, it’s time to recalibrate: Stephen Jen

The U.S.-Japan joint intervention to strengthen the yen in early August marked a watershed moment in ​currency markets that could recalibrate expectations for Japan’s currency, likely leading to a significant revaluation in the coming years. The joint action was a ​big deal. It was the first time since 2011 that the U.S. Treasury had conducted a ‌joint intervention with ​Japan, and the first time since 1998 that it had bought yen in concert with Tokyo’s Ministry of Finance. The move has had a meaningful impact. The yen is hovering around 158 per dollar, compared with a peak near 164 in late July. But ultimately, these actions were “defensive.” They simply helped halt the weakness in the yen. To truly drive the dollar-yen rate lower and persuade Japanese institutional investors to refrain from expatriating capital, the Ministry of Finance will need to ‌be more offensive. The question is whether it is capable of doing this, but the partnership with Washington could be a signal that Japan is ready to do whatever it takes to shift the narrative. WHY NOW? In the last four years, the tumbling yen has generated long-desired inflation in Japan and flattered corporate profits, supporting a massive bull run in the country’s equities. This is great, right? Why, then, should Japan be concerned about a weak yen? Weak currencies may sound attractive because they make a country’s exports more competitive, but over time, they can create inefficiencies, such as enabling uncompetitive corporate behaviour and distorting trade balances. There are also implications for capital flows. ‌If a currency is expected to depreciate, why should capital not flow out in anticipation of losses on domestic asset holdings? Moreover, when a currency weakens too much, it risks plunging an economy into a danger zone marked by disorderly bond moves, weak consumption and plummeting capital investment. Given the yen’s sharp depreciation ‌against the dollar since 2022, Japan faces this risk. Of course, Japan’s interventions in the foreign exchange market also come with potential hazards. Government efforts to support the currency could trigger an avalanche of unwinding and repatriation, given the large overhang of yen carry trades.

But for Tokyo, the status quo is unsustainable, so this risk may be one worth taking. WHAT’S IN IT FOR THE U.S.? What about the rationale on the U.S. side? Treasury Secretary Scott Bessent indicated that the joint intervention was driven largely by financial stability concerns. He noted that the relentless rise in the dollar against the yen was reminiscent of the 1997-98 period, when the rise in this cross rate helped trigger the Asian Currency Crisis. But I suspect another motive: the desire to strengthen America’s manufacturing competitiveness. Reshoring a critical mass ⁠of U.S. manufacturing ​to boost U.S. jobs and ensure national security is clearly an overriding objective of the ⁠Trump administration. To achieve this end, the dollar will need to be weaker. But the challenge is to engineer a weaker dollar without undermining the world’s holdings of U.S. dollar assets – both bonds and equities.

One way to do this is to engineer several small “Mar-a-Lago Accords” that chip away at the value of the dollar without imparting a general expectation of future dollar weakness. By stringing together ⁠a series of “mini-lurches” that surprise the market, the U.S. could deflate the value of the dollar over time without creating expectations of further depreciation. If that’s the case, surprises like the one earlier this month could become more common over the next two years. CAN IT WORK? An excessively weak yen is clearly counterproductive for both Tokyo and Washington, giving each a ​strong incentive to ensure that – one way or another – the dollar-yen rate starts falling. The question is whether Tokyo has the ammunition to sustain this fight. Japan’s most recent official data, which do not fully include the latest interventions, suggest the Ministry of Finance had $1.1 trillion in liquid foreign ⁠reserves as of last month. If we assume that most of this is already in dollars, either in cash-like form or held in Treasuries, this would be equivalent to around 56% of daily yen turnover. These large foreign reserve holdings are not a strategic buffer against financial instability but are simply the result of the Ministry of Finance’s defensive interventions. So selling a portion of this stock should not ⁠expose ​Japan to financial dangers.

Of course, any further operation larger than around $130 billion would require Japan to start selling large amounts of U.S. Treasuries – a move the White House might oppose given current anxieties about rising Treasury yields. To avoid this, Japan would likely need exceptional arrangements, like increasing its Foreign and International Monetary Authorities repo facility with the Federal Reserve. Would U.S. Treasury Secretary Bessent be willing to come up with creative options? The recent intervention – in which Japan was encouraged to tap this facility – suggests yes. There is another lingering question. Can the yen strengthen if the Bank of Japan remains slow to tighten monetary policy despite high inflation? Again, ⁠recent history suggests yes. Japan began its yen interventions in 2022, when the Fed started hiking rates. Since September 2024, the Fed has cut interest rates by nearly 200 basis points, while the BOJ has raised rates by 75 bps. This 250 to 300 bps compression in yield differentials appears to have ⁠had no discernible effect on the dollar-yen rate.

It is thus not evident that a ⁠more hawkish BOJ is either a necessary or sufficient condition for the yen to strengthen against the dollar. Ultimately, the joint intervention's most important message may be the determination of the U.S. and Japan. Neither appears willing to give up or concede to the market. For investors, resistance may be futile. (The views expressed here are those of Stephen Jen, the CEO and co-CIO of Eurizon SLJ asset management.)

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