Currency intervention: a new front in the financial war

EUR/JPY

Key zone: 180.50 - 182.00

Buy: 182.50 (on strong positive fundamentals); target 183.50-185.00; StopLoss 181.90

Sell: 180.00 (on a pullback following a retest of 181.50) ; target 178.50-176.50; StopLoss 180.60

For the first time since 2011, the United States and Japan have carried out a coordinated currency intervention to support the yen. Over four trading days, the Japanese currency strengthened by more than 4.5%. But the market is no longer focused on the exchange rate. It is focused on the cost of that support.

A weak yen has long ceased to be solely a Japanese problem. It drives up import prices, intensifies inflationary pressure, and raises household living costs. It has now become a political risk factor for the world's two largest economies.

Let's recap.

Japan's foreign exchange reserves consist primarily of U.S. Treasury securities. To buy yen, the Bank of Japan must first sell dollar-denominated assets. In effect, support for the national currency is financed by reducing Japan's holdings of U.S. government debt. As a result, the yen's weakness is gradually becoming a problem for the U.S. Treasury market as well.

The reasons behind the yen's decline remain unchanged.

• The primary factor is the interest rate gap. With the Bank of Japan's policy rate near 1% and the Federal Reserve's rate at 3.5–3.75%, global investors continue borrowing cheaply in Japan and shifting capital into higher-yielding U.S. dollar assets.
• The carry trade continues to work against the yen.
• Additional pressure comes from higher energy import costs following the conflict in the Middle East, as well as President Trump's tariff policies.
• Japan's public finances remain another major concern. Government debt exceeds 200% of GDP, budget deficits persist, and the debt burden continues to be refinanced through new borrowing.
• President Trump has repeatedly criticized the weak yen, arguing that it gives Japanese exporters an unfair competitive advantage. As early as last March, he suggested imposing tariffs on Japanese goods.

The intervention buys time, but it does not solve the underlying problem. Selling dollars strengthens the yen while simultaneously withdrawing liquidity from the Japanese economy, helping to ease inflationary pressure. However, the effectiveness of this mechanism is limited by the size of Japan's reserves.

Japan currently holds approximately $1.1 trillion in foreign exchange reserves, but they are being depleted at an alarming pace. For example, at the end of April, authorities spent nearly $74 billion supporting the yen, yet the effect lasted only one quarter. By July 23, the yen had fallen to its weakest level against the U.S. dollar since 1986. According to preliminary estimates, authorities injected another $84 billion into the market at the end of last week. At this pace, even the world's largest reserve holdings no longer appear unlimited.

The greatest risk lies not in Japan, but in the United States. If the world's largest foreign holder of U.S. government debt is forced to accelerate Treasury sales in order to support its own currency, pressure on the Treasury market could intensify dramatically.

Washington would then face highly unpopular choices—cutting government spending and finding additional sources of budget revenue. Ironically, it was the U.S. Treasury that initiated support for Japan, yet its resources are nowhere near comparable to those of the Federal Reserve.

The Treasury cannot print money, does not control the money supply, and lacks sufficient foreign exchange reserves to sustain interventions of this scale over the long term. In practice, the current support is being financed by American taxpayers. All of this could ultimately become a political liability for Treasury Secretary Scott Bessent as evidence of imprudent financial policy.

So, what does this mean?

Time is working against the Bank of Japan. Tokyo is likely to continue drawing down its reserves while hoping the Federal Reserve eventually cuts interest rates.

The market, however, is moving in the opposite direction. President Trump's policies are increasing inflationary risks, and Federal Reserve officials are discussing the possibility of another rate hike more frequently than rate cuts. If that scenario materializes, the Bank of Japan may have no alternative. A rate hike as early as September is becoming increasingly likely.

As long as the interest rate gap between the United States and Japan persists, pressure on the yen will continue to return.

For traders, this means sustained volatility in both currency and bond markets. The key variables remain Federal Reserve and Bank of Japan policy decisions, U.S. Treasury yields, and the possibility of further currency interventions.

If structural problems are not addressed in time, today's battle to defend the yen could become the opening chapter of the next global financial crisis.

So we act wisely and avoid unnecessary risks.

Profits to y’all!