What the US-Japan Currency Intervention Means for the Yen, Rates, and the Dollar

0:04Karen Fishman:The United States and Japan have coordinated the largest currency market intervention in 15 years to help stabilize the yen. After more than five years of yen weakness, it's left investors asking the question, why now? I'm Alison Nathan, and this is Goldman Sachs Exchanges.

0:24Karen Fishman:To understand the why and the knock-on effects for currency markets, I'm sitting down with my colleague in Goldman Sachs Research, Karen Fishman, and Praneet Shah, who leads foreign exchange options trading within our global banking and markets business. Praneet is joining me from London, and Karen is here with me in the studio. Karen, Praneet, welcome to the program. Thanks for having me. Thanks, Alison. Karen, let's first level set for the generalist. Talk us through what happened and why this is a big deal. So on July 30th, Japan conducted or began its biggest intervention in the FX market in 15 years.

1:01Karen Fishman:So they sold U.S. dollars to buy Japanese yen in an effort to halt the weakening that we've seen over much of the past year, but especially over the past few months when the yen hit 40-year lows versus the U.S. dollar. And this was a big deal for both its size and its scope. So in terms of the size, we won't have the official numbers for another month, but we can use indirect data to get a broad sense of how big it was. So things like interdealer trading volumes and BOJ data. And so there are a number of figures floating out there, but we've estimated over the first couple of days, so July 30th through July 31st, that it probably amounted to up to$85 billion.

1:44Karen Fishman:And maybe there was a bit more done on August 3rd as well, since volumes were elevated that day, too. And so to put these numbers into context, that would be Japan's biggest two-day intervention in the FX market on record outside of October 2011, which was in the aftermath of the Fukushima disaster. And then in terms of the scope, it was also coordinated with the United States, as you mentioned. And this type of joint action hasn't been taken also since 2011, a week after the Fukushima disaster. And actually, I think it's worth noting that also that intervention was coordinated across the broader G7.

2:22Karen Fishman:So this is just the U.S. and Japan, so maybe a little bit less significant from that perspective. But of course, the U.S.'s involvement is significant nonetheless. I want to dive into so much of that, but let's just take a step back for one moment. Why has the yen been so weak for people who don't follow it that closely? It's mainly a consequence of Japan's domestic policy mix. The government is pushing through big spending plans, and the Bank of Japan has been hiking interest rates only very gradually over the past couple of years. Markets view that combination as inflationary. So in other words, those rate hikes are insufficient to contain the rising inflation risk.

2:58Karen Fishman:And so if inflation is rising and rates aren't keeping up, real returns go down. And so investors move their money elsewhere or even bet against the yen. And so that's pushed the yen weaker. Now, it hasn't just been the domestic policy mix that's been weighing on the yen. It's also been a function of the broader macro backdrop. And really, despite all the volatility we've seen at periods throughout this year around AI, oil and Fed expectations, we haven't really seen recession odds go up. And so you haven't really seen that demand for safe haven assets like the yen. And also, similarly, strikingly, FX volatility has remained very low.

3:35Karen Fishman:And so that's a good environment for carry trade. So investors have been leaning into those. So buying higher yielding currencies and selling lower yielding currencies like the yen. But remind us why a weaker yen is something Japan doesn't want. So a weaker yen makes imports more expensive. So think higher prices at the grocery store, higher gas and electricity costs, more expensive overseas travel. All of these things weigh on households and businesses. Now, it also raises government borrowing costs, which is, I'm sure, a focus as well. And at the same time, though, it is beneficial for exporters and also tourists coming to Japan.

4:14Karen Fishman:But from a broader economy perspective, it raises the cost of living. So the case of Japan's interest in this intervention, I think, is pretty clear, as you just said. But why does the U.S. want to be involved? What does it get from a stronger yen, a more stable yen? Yeah, that's a great question. And I would just start off by saying that volatility in one market often spills over into global markets. So a weaker, more volatile yen should mean a stronger, more volatile dollar. And that can raise financial stability concerns, weigh on growth expectations, and then amplify those initial concerns so you can kind of see how that would be an undesirable mix.

4:52Karen Fishman:But I think really the key question has been what to make of the U.S.'s involvement. And that's been a bit of a debate. On the one side, coordinated intervention often signals some alignment of policy goals. And intervention is often most effective when it signals an imminent shift in policy, so monetary policy expectations usually. And the Bank of Japan has signaled already its openness to a faster pace of hikes. And so markets have taken this as a reason to put higher odds or really think that it's more likely than not that the Bank of Japan will be hiking rates again at its next meeting in September.

5:26Karen Fishman:And I think that that's fair to some extent. But the other side of the debate is that the U.S.'s involvement is more about maintaining the volatility or limiting the volatility in U.S. market. And there are really three reasons why that's a more compelling explanation to us. First, the U.S. administration has been encouraging the expansion and use of the Fed's facility that allows central banks to raise dollar cash by selling their U.S. treasuries to the Fed and then agreeing to buy them back later. So basically, this would be a way for Japan to avoid putting abrupt upward pressure on U.S. interest rates by having to sell U.S.

6:06Karen Fishman:treasuries on the secondary market to raise that cash for intervention. So I think that's probably the clearest example of U.S. market functioning being a top concern. The second reason is the timing of the U.S.'s support for Japan. So basically, Japan has made a few efforts this year to support the currency. And it seems like the U.S. has joined in on those efforts when there has also been upward pressure or some volatility in U.S. interest rates. So just to kind of quickly walk you through that, back in January, both Japan and the U.S. signaled to the market that they might intervene, but then they ultimately didn't.

6:42Karen Fishman:Then in April, Japan did intervene, but on its own. And then, of course, now in July, Japan intervened in big size and the U.S. did join in. And both in January and in July, there was some more volatility in U.S. interest rates kind of going into those periods of action, whereas in April there wasn't. And so I think that pattern also clearly shows that market functioning is a key consideration. And then the final one is just the scale of the intervention. It looks to be a lot smaller, the U.S.'s operation relative to Japan. And so also the timing of the intervention in the market wasn't choreographed like prior coordinated interventions have been.

7:21Karen Fishman:And so it does seem to really be more about the signal of support and ultimately the U.S.'s focus on market conditions rather than taking a strong view on where the end should be. Put some numbers on that for us that the U.S. leg of this intervention was a lot smaller than the Japanese leg. So we don't have the official numbers yet. And so similarly, you can rely on traded volumes and price action. And ultimately, it just looked a lot smaller. And historically, coordinated interventions or the U.S.'s participation in these coordinated interventions tends to be a lot smaller. It's been historically around$1 to$2 billion.

7:55Karen Fishman:So again, more about the signal than actually driving the currency in a certain direction. Praneet, let me bring you into the conversation. You were sitting on the trading floor in the middle of all this as this intervention was unfolding. What did that look like in terms of volumes and moves? Walk us through it.

8:13Praneet Shah:Thanks, Alison. It's useful to split it into two parts. If you first look at the MOF, which is the Japanese Ministry of Finance, they intervened on the Thursday and the Friday. Like Karen said, it's$60 billion on a Thursday and around$25 billion on the Friday. We think there's another 20 billion possibly on the Monday as well. And this compares to about 30 billion average daily volume traded in the market. So it's pretty sizable in comparison. You can also look at a second part of this. You can see how much we think actually traded in the market overall. The best way to get an idea of this is EBS, which is the main spot exchange that we look at.

8:52Praneet Shah:That typically trades around 5 to 10 billion a day. So when you look at the actual numbers that were posted on the Thursday and Friday, it was about 90 billion on the Thursday and 80 billion on the Friday. So even more sizable in comparison to what a usual day looks like. So you can imagine what we saw on the trading floor. I think it was one of shock and surprise. But when you look at the size of the moves, 3 % was the move that you saw between Thursday and Friday. That's more or less in line with a usual episode of intervention from the MOF. I think what took us a bit more by surprise was the subsequent 2 % move thereafter once there were some signs that there was coordinated intervention with the US.

9:32Praneet Shah:I think despite the fact, as Karen just said, that the volumes actually weren't that large from the US side, I think that symbolism to us is actually quite interesting to look at because they managed to move it 2 % despite significantly less volumes compared to the $85 billion that the MLF had used. The last point to note is in terms of the loss of momentum, the market was really looking at this 200-day moving average in yen. We managed to breach below 158. And I think that's another symbolic level to just show the extent to which they managed to move the currency that day.

10:04Karen Fishman:So when you talked about the 2 % move, 3 % move, we're talking about the dollar-yen exchange rate, just to be perfectly clear. So Praneet, how did clients respond to this? What were they motivated to do? What were they forced to do?

10:17Praneet Shah:I think the response on Thursday, Friday was one of shock and surprise. I think the actions, especially on Thursday, caught the market off guard. When we say we estimate around 60 billion was transacted by the MOF. When you actually drill down into how it was done, it was all done in a very short space of time, which is very unusual compared to past episodes of intervention. So I think that surprise was the main thing. When you look at the factors, such as there's no forewarning before they did it, unlike April, May, the past intervention. Realized vol wasn't that high, unlike previous episodes.

10:52Praneet Shah:When you look at the level of dolly yen at 164, it had traded earlier that month. So these are all conditions that had set the scene such that traders on the seat didn't really expect this to happen. And you had the Bank of Japan expected to set interest rates on the Friday. Again, it's very rare that they've intervened the day prior to that actually happening. Now, when you look at the price action after, the first round of flow we saw was cutting from the leverage community. So if you look at the reasons to want to be long Dolly N, the main reason has been carry. So you get 2 % or 2.5 % of annualized carry, but you also get another element of spot appreciation in Dolly N exchange rate.

11:33Praneet Shah:Now, if Dolly N just suddenly gaps 3 % lower in a given day, that's your entire annualized carry just wiped out in one move. So for risk management considerations, if you're levered in terms of a hedge fund or a CTA, you really do end up needing to stop out. And I spoke about that 158 level, which was the 200-day moving average. And I think that was a key catalyst on the Thursday and the Friday that really did cause people to cut positions. We actually had some data out today from the CFTC when you look at positioning. It's actually the fourth largest absolute reduction in the yen positioning in the 20-year history that you've seen.

12:08Praneet Shah:So it does really put some context into how much squaring you actually did see in this episode. I think the other thing to note is euro yen is where we've actually seen a lot of interest from clients. Usually it's dolly yen, which is the main liquid pair. If you look at what they actually did in terms of the intervention, like I said before, Dolly Yen had traded 164 prior in the month in July, but 187.50 to us looks like a key level in Euro Yen. It triggered the April to May intervention back a few months ago. And again, it traded on that Thursday, and it again looks like it triggered the intervention there.

12:44Praneet Shah:So clients have been much more willing to play Yen's strength looking at the cross Euro Yen rather than Dolly Yen.

12:49Karen Fishman:And is that because also U.S. involvement here? Is it a factor in their decision making?

12:55Praneet Shah:Yeah, I think that goes some way into looking at it. When you have coordinated intervention, I think it's more powerful than unilateral intervention. I think if you think that the MOF were targeting themselves the euro yen exchange rate, you now just have the added kicker that you also have the U.S. side looking at that cross as well. And if I take a step back, the initial flow we actually had seen was the same April to May playbook. I think the market had seen a dip lower in dolly yen. And the first instinct was for many to just buy the dip and to play for a grind back towards 164. But I think last week, when you look at our flow, it's been surprising to me how mixed and balanced that actually has been.

13:33Praneet Shah:You've seen really good two-way interest where half our client base want to play for continued yen strength, targeting a move even down to 150 in dolly yen and a 5 % move in euro yen as well. But the other half really just want to buy the dip. And it's a view that nothing structurally has actually changed here. It just takes the wind out of the short-term move in the end.

13:54Karen Fishman:Well, I want to ask you more about that, Praneet, because ultimately, as you're looking at this price action, does this intervention or interventions broadly that we've observed work, given that a lot of the gains have already been given back?

14:06Praneet Shah:Yeah, so I said it's moved 5 % from high to low. And now when you look at the price today, it's only now moved 3 % net. I think the effect it has had is one in which it stabilised the exchange rate rather than fully reversing the structural weakness. I think that's important to differentiate. And I think if the BOJ and MOF were just targeting more stabilisation rather than a rapid appreciation, you could argue that this has been successful. The 3 % move is just in line with past episodes, but they have had much less bang for butt. We've said that they've intervened in much larger size and they've achieved the same net outcome.

14:43Praneet Shah:So they probably will be a bit disappointed by that. I think it's worth also looking at the options market. So when you look at the implied moves from the options market, there's still significant risk premium in two week to one month yen call options. What that basically tells you is that there's still heightened sensitivity by the market that you could get a rapid gap move lower in dolly yen and euro yen still. So I think the market is still really worried about the fact that there could be this sharp move in yen. And I think that's going to be quite good for the BOJ and the MOF. If spot is trading up into 160, there's a real risk that you don't want to continue selling yen when you've got this large risk of a drawdown still priced by the market.

15:26Karen Fishman:And Karen, what do you make of all this in terms of the effectiveness of the intervention? Can it be a sustainable fix? So no, it's not a sustainable fix that ultimately just buys some time. So basically, it pushes investors or forces investors out of their positions and then ultimately leads to some more muted performance thereafter as investors are wary of additional intervention and ultimately are more reluctant to get back into those positions. But what we've said is that if there's no subsequent policy shift, those existing pressures on the currency tend to reemerge. And that's actually exactly what we saw happen after the prior intervention earlier this year that Japan conducted on its own at the end of April and early May, where ultimately within a few months, the yen was hitting 40-year lows.

16:14Karen Fishman:So do we think another intervention is potentially on the table, potentially likely? And I think a question that's being asked is, how much capacity does Japan actually have to continue these types of interventions, given the size and scale of it? So in terms of the likelihood, it's always hard to know for sure. But Japanese officials have said that they won't hesitate to get back in if they feel the need. And I do think that there's some credibility when there was coordinated intervention. But in terms of the capacity, the short answer is they have plenty. But just to kind of give you some numbers around that, Japan has about a trillion dollars worth of FX reserves in U.S.

16:54Karen Fishman:dollars. And we've estimated that about 200 billion of that after the likely size of this intervention is in cash or cash equivalents. So they already have at their disposal enough to do another couple rounds of what we just saw, which, again, were near sort of record size. And then theoretically, if they are able to use the Fed's facility, then they would have access to that full trillion dollars in sort of a more liquid way. Now, realistically, they wouldn't come close to using all of that. But I think that just hits home the point that they have plenty of capacity to keep intervening if they wish.

17:27Karen Fishman:So plenty of capacity. But Praneet, there are other measures being discussed among clients and on the trading floor in terms of what else Japan might do here. Talk us through some of that.

17:38Praneet Shah:Yeah, I think Karen mentioned it previously, but the FEMA facility at the Fed has really caught a lot of clients' attention here. I think when you look at the composition of the reserves,$1.2 trillion,$200 billion were readily available in cash. But this facility, I think there's more of a signaling impact from it. When you unlock a trillion dollars of the balance sheet that potentially now can be used for ready intervention, That's one of the main reasons that clients really did get quite bulled up on the yen earlier last week. And look, the overwhelming driver of the exchange rate has really been the carry differential.

18:15Praneet Shah:So you can split that up into two paths. So one, you look at the path for Japanese interest rates. The market's extremely focused on the September Bank of Japan policy meeting now. So there's a 65 % chance that they hike 25 basis points. That I think they really do need to deliver on. And that's one of the key variables now, I think. You've got 40 basis points priced in terms of hikes into year end. Again, I think the Bank of Japan is really going to need to hike faster than expected if they really want to address one of the medium term drivers. And then you've got the other aspect of it. You've got the US side of the equation.

18:50Praneet Shah:You've got energy prices are an input into that. You've got CPI inflation you get later this week. If you happen to get a cooling in price pressures in the US, I think that is something that clients will look at in helping take some of the stress away in some of this pressure in yen weakness. So I think if you rewind back to July 2024, that was quite interesting. You saw a miss in US CPI. And one of the most effective rounds of BOJ MOF intervention was actually on that miss in US data. And you also had the follow up in the payroll miss as well straight after. So I think this week is going to be important.

19:26Praneet Shah:I think it's worth keeping an eye on the US side of the equation as well. And any misses, I think the market will really start to increase expectations of a subsequent intervention later this week.

19:36Karen Fishman:And Karen, do you share Paneet's view in terms of the importance of this BOJ meeting and what do we expect there? What I'll say is over the past few years, Japan has been intervening in the FX market and it's still depreciated. And so I think that's been a clear reflection of this point I just earlier made, that it only buys some time unless subsequent policy changes occur. And so that being said, though, I do think that we could see stronger yen levels for longer if we do see some follow-ups to this event. Intervention alone really isn't enough, but one of those things would be a hike in September.

20:12Karen Fishman:If they don't deliver that, that would put renewed downward pressure on the yen. But then I think you would need to see also some other shift. So whether that's global growth market worries emerging, whether that's around AI or not, just a reason to see an increase in safe haven asset demand, that could be sufficient. But otherwise, I think it would have to be something else on the domestic policy front. And related to that, the Japanese administration has reportedly been focused on encouraging Japanese investors to shift back to domestic assets. And that would be a big deal since over the past decade, those Japanese investors have been raising their share of foreign asset holdings at the cost of domestic asset holdings.

20:53Karen Fishman:And so if that were, and that's part of why, actually, I should note that the yen has been weak on our models or undervalued on our models. And so if that were to reverse, that would be a meaningful source of more sustained yen appreciation. But I think there are a few hurdles to that. And these things tend to take some time. And most importantly, return prospects abroad are still more attractive than Japanese assets. But if that were able to occur, I think that would lead to a more sustained period of yen strength. I was just going to say, it's perfectly rational that Japanese investors were looking beyond because of the return profile elsewhere.