Japan Likely Sold Treasuries to Fund Record Yen Intervention

According to data from the finance ministry, Japan experienced a significant drop in its holdings of foreign securities in May. This indicates that the government likely financed its recent currency market intervention, aimed at strengthening the yen, by selling off Treasuries and other foreign securities. Despite this, Japan still has ample resources to intervene in the markets again if necessary.

In May, Japan’s holdings of foreign securities decreased by $50.4 billion, following its intervention of ¥9.8 trillion ($62.7 billion) in the past month. It was expected that the market value of Japan’s foreign securities would increase if the assets were left untouched, as Treasury prices rose during the same period.

Although foreign deposits, which are often considered an easier source of funding for intervention, saw a slight increase to $159 billion, the total official reserves decreased to $1.23 trillion. This suggests that foreign deposits were not a primary source of funding for the intervention.
Japan has more intervention options than just its foreign currency reserves, as it is willing to sell Treasuries. This provides officials in Tokyo with the flexibility to take action multiple times if necessary.

According to Kaoru Shoji, an FX strategist at SMBC Nikko Securities, there is a high likelihood that the finance ministry sold foreign securities, particularly US Treasuries, to finance its interventions. However, Japan still has plenty of intervention firepower left and will need to maintain close communication with foreign counterparts when taking any action.

The decrease in foreign security holdings indicates that Japanese authorities used the same funding sources for market intervention this time as they did in 2022, when they spent ¥9.2 trillion to support the currency. It is believed that the government financed three operations in part by selling US government bonds at that time.
It appears that Japanese officials may have received some form of tacit approval from the US for selling US bonds. However, officials in Washington have expressed a preference for limited market intervention.

US Treasury Secretary Janet Yellen has emphasized the importance of using currency intervention sparingly and providing advance notice. She stated that the Group of Seven nations have agreed not to manipulate exchange rates unless extreme volatility is present.

Shoji, an analyst, suggests that Japan may have received pre-approval from the US for their interventions by cashing in on Treasuries.

When asked about the funding of the interventions, Finance Minister Shunichi Suzuki declined to comment, stating that officials need to consider the necessity and effectiveness of intervening in the market.
Earlier in the week, Suzuki justified the recent interventions, claiming that they had successfully countered extreme currency fluctuations. However, some analysts speculated that the use of securities by the finance ministry was a strategic move to refute the notion that they are running out of options for market intervention. Tsuyoshi Ueno, a senior economist at NLI Research Institute, noted that the intentional reduction in securities and increase in deposits for funding the intervention was likely aimed at dispelling concerns about the ministry’s limited remaining capacity for intervention.
Despite the recent surge in spending to support the yen, interventions have proven to have only a temporary impact on the market dynamics. In May, intervention efforts brought the yen to around 157.52 per dollar, but the currency quickly reversed course and the dollar rose back to the lower 156 yen range within hours.

However, interventions can deter speculators from heavily betting against the currency due to the fear of further action. In this sense, interventions can buy some time until there is a fundamental change in the exchange rate.

The yen is expected to remain under pressure due to the significant interest rate gap between Japan and the US. Japan’s short-term interest rate stands at a mere 0.1%, while the Fed’s rate is at 5.5%. Although the Bank of Japan is anticipated to increase interest rates in the coming months, the possibility of rate cuts by the Federal Reserve has diminished as the US economy continues to perform well.
According to Shoki Omori, chief desk strategist at Mizuho Securities Co., there are still more options available for intervention if USD/JPY surpasses the 158 and 160 levels, which are already causing market caution. Assistance was provided by Toru Fujioka, Ruth Carson, and Daisuke Sakai.