Why the yen matters

0:06Cushkin. Currencies lack the glamour of stocks and the clever, clever cachet of bonds, but the cool kids know that the foreign exchange market is the biggest and baddest of them all and the one that really matters. And listeners, wild things are happening here. It's like all the Christmases and birthdays combined for currency nerds, and everyone else needs to care about it too. The main character energy here belongs to the Japanese yen. It's weak, really weak. Japanese authorities have been battling, kind of, to prop it up. And now they have a new comrade in this effort, the United States of America, which is buying yen and pledging further support.

0:50This is super rare. Countries hardly ever team up on currencies like this, and it might not be over. So today on the show, we're going to tell you what's going on, the real reasons why, and whether it's going to work. This is Unhedged, the markets and finance podcast from the Financial Times. I'm Pushkin. I'm Katie Martin, a markets columnist at the FT in what used to be a lush and leafy London until someone cancelled rain. With me in the studio down in the bunker at FT Towers, I have the very lovely Toby Nangle from FT Alphaville. He's a nerd's nerd who's been digging through the archive on this historic joint intervention.

1:29Toby, thank you for coming. You're a big upgrade on Rob. Hi Rob, anyway, if you're listening. Hi Rob. He's out in the wilderness. We can forget about Rob. Okay, let's start with what's going on. Just crazy stuff for people who are very boring like me, who've been covering and thinking about currencies for a long time. So late on July the 31st, the market was nice and quiet. It was like a Friday evening in London. Something went bump in the night and it was the dollar-yen exchange rate. So bring people up to speed, like what's going on here? Okay, right. So I guess two things happened. First of all, I mean, the Ministry of Finance and the New York Fed, well, the Treasury through the New York Fed, have been rattling sabers for a little while.

2:21And the Japanese have actually been doing bits and bobs of intervention. But as you say, at the end of July, the Ministry of Finance came in with 8.45 trillion yen worth of intervention, which is worth 53 billion dollars. So, you know, quite a chunk of change. So that's on the Japanese side. That's on the Japanese side. They've been trying to control this thing, trying to prop the currency up because it's hit its weakest point in like 40 years against the dollar. Like weak, weak. Yeah, properly weak. Yeah, yeah. And then, you know, along come the US and the US have, they joined the party too. The sort of long and short of it, I guess, is that the US came in through the New York Fed and just bought a truckload of yen in an effort to push the value of the currency up.

3:03and you know maybe to normal people that just sounds like oh okay they're just you know propping a currency up when it's super low but like finance people were all like I'm sorry like what like yeah because I got you know I heard from someone in the market on that Friday night saying you know got a weird one for you here like New York Fed's in the market buying yen and I was like okay dude you know it's Friday night things can get exaggerated but no that was exactly what was happening but give us a sense of how unusual this really is okay right so i i still think of myself as a young sprightly you know person but i'm properly old now i started i started joint i started working in the city in 1997 and i remember you know the new york fed intervention in 1998 in in june and that was a huge big deal and then the next big coordinator intervention uh across different countries was in the wake of the you know the tsunami the fukushima yeah uh thing that was in 2011 but those are the two instances that's that's it that's my entire crew just had the third one yeah um so it is a big deal it is unusual it's extremely unusual now a few interesting things here so although we're saying this is super unusual and it really is and the yen it should be stressed as one of the most actively traded currencies in the world it's the third most actively traded currency in the world.

4:26It's a biggie. But weirdly, if you think back to, I think it was October last year, under the direction of Scott Bessent, the US Treasury Secretary, the US also stepped in to support the Argentine peso. So that was very weird. And I guess this intervention in the yen is just another demonstration of the US likes to show who its friends are and likes to show okay there's a country over here that's in some sort of financial distress we are the united states of america we're going to turn up in our superhuman or you know superhero costumes and and save the day it's kind of got a similar vibe about it but so the u.s rolls in it buys yen and that does actually kind of sort of work so it does i mean it moves it moves quite a lot i mean dollar yen moved over two days five percent and then you know g7 major currencies that's a huge two-day move yeah um euro yen which is what they're actually intervening and to be fair moved about four percent but still you know who's counting i mean apart from us so so there was a reasonable size jump in the yen but let's just quickly rewind and go back to that point you just mentioned which is that to do this the u.s wasn't selling dollars against the yen so it wasn't buying yen using dollars it was buying yen using euros yeah huh huh like multilateral interventions like this as as we've established super super rare multilateral interventions in somebody else's currency i have never heard of that before of you i i i can't think of it now Honestly, it's, yeah, I mean, it is a weird one.

6:10And, you know, I mean, maybe they were just doing an asset allocation change. Current intervention, I don't know. No, it's very unusual. But I guess the sort of most straightforward reason why they were using euros to do this is that the US has this pot of money that is available for use in stabilizing currencies. And the vast majority of that, I gather, is in euros and yen. That just is kind of what they've got to hand. Yeah. So the exchange stabilization fund and then also the Fed's so-called SOMA account, they kind of run as a mirror of one another. And they're basically like two thirds euro, one third yen.

6:54And so you kind of go, well, how much, how many euros do they have to possibly sell if they sold every single last one of those euros? And it's about 28 billion, so about half the size of the Japanese intervention, if they were going to just do it that way. But again, an interesting wrinkle here is, like we say, super, I think unprecedented for anyone to intervene using somebody else's currency like the US has done here. But as the FT reported, they hadn't given the European Central Bank a heads up here. They called them afterwards and said, oh, yeah, that. No, no, sure. No, yeah, we did sell euros.

7:31But there's a problem potentially here, right? Because what euro assets were they selling? Were they selling German government bonds, Italian government bonds? How does this work? So, I mean, yeah, on August 30th, we'll get a statement and we'll find out whether assets were sold. Or it's quite possible that they didn't actually sell any of those assets and they just sold the currency on a kind of a forward basis. and then they can just roll that without ever having to liquidate the assets. But yeah, but most of those euro assets, yeah, they're mostly in French government debt, to be fair. Oh, really?

8:02Yeah. So that's a kind of, it's a bit of a sort of faux pas, would you say? It's certainly a very weird thing to do to somebody else's currency. But why did they do this? So Donald Trump's explanation for this, I'm going to read the quote in full because it's low-key hilarious. He said, I'm not going to do the accent. They have a weakening yen and they wanted a little bit of help. And we're always there for Japan. So far, so good. And then he said, Japan's been very good to us. With the exception, of course, of Pearl Harbor.

8:43You just cannot make this stuff up. But so on some level, yeah, Japan and the US are friends. Japan wanted help with its currency, which is weakening, which is a problem because it makes imports into Japan much more expensive, including oil, of which Japan has, I think, none of its own. So it needs imports. And this is pushing up inflation, which is already a bit of a problem in Japan, very, very unusually. So they wanted some help with the currency and the US was only too happy to oblige. but you have to the US I mean yes it likes to be a good global neighbor but there's some potential self-interest yeah no absolutely absolutely I mean you know Japan is you know it's a large economy it's you know it's a it's a really big economy but I think that the US could probably happily ignore lots of it in different ways yeah but the bit it can't ignore is that it's a real global titan when it comes to government bond markets, government bond holdings.

9:48Yeah, this is the piece of the puzzle that you've really kind of got to understand, right? So like Japan is a massive, massive holder of US government bonds. It's got over a trillion dollars worth of these things. I think that's about 4 % of the total. Like it is the 800 pound gorilla in the US government bond market. Now, if it's a problem for Japan that they think their currency is too weak, they can do one of two things. The first thing is they can jack up their own interest rates really, really hard. Now, this is a problem potentially for Japan. It's politically quite delicate and it's economically quite delicate.

10:29So we've got some analysis here from a Japanese bank called Mizuho and they are pointing out that jacking up interest rates really hard, there are concerns about the impact of higher borrowing costs on households with mortgages and on small and medium-sized businesses. So Japan is so unaccustomed to higher interest rates that just ratcheting them higher really quickly could have quite nasty economic effects that Japan would be quite nervous about. But option two for the Japanese authorities, if they really want to support the yen, is that they could dump a lot of these treasuries that they currently own.

11:06Like not all of them, let's not be silly. here. But they could sell a lot of them in pretty short order. They've already sold some. That's a problem for the US, right? Yeah. I mean, so having a large amount of extra bonds being dumped onto the market on top of the 7.5 % of fiscal deficit of GDP that the US is essentially dumping on the market in printing new bonds each year. Yeah, that's a big source of unwelcome supply from their perspective we're pushing yields higher president trump wants yields to be low uh scott wants yields to be low everyone wants you everyone likes lovely low borrowing costs nice free money and the problem that the u.s has is that the the benchmark 10-year government bond yield so that's kind of the borrowing cost for the u.s government at a 10-year horizon is already 4.7 percent that's pretty high by historical standards.

12:01And the 30-year US government bond yield is like over five. It's 5.2%. So Uncle Sam is already paying up a lot of money to borrow. And as you say, it has a 7 % fiscal deficit relative to GDP. So it needs to borrow an awful lot of money to keep the wheels turning for stuff that the US wants to spend money on, defence, education, infrastructure, or those other lovely things. It likes borrowing. And normally this suits everybody because there are lots of countries around the world that have got dollars sloshing around. They need to put them in something. So they put them in US government bonds. The US wants to borrow lots of money.

12:41Everybody's happy. But the very strong suspicion here is that this is the real target of this intervention. What the US is stepping into support is not really the yen. It's itself. I think it's, yeah, It's the U.S. Treasury market, either by means of making sure that the Bank of Japan or the Ministry of Finance don't sell treasuries. But also, I mean, I think they'd quite like Japanese government bonds or JGB yields to stop going up. You know, I mean, I think they'd be quite happy if they racked up short-dated overnight rates. Because I think that they would believe that you'd get a flatter curve.

13:21That is to say, higher short rates, but maybe lower long rates, because everyone would think inflation's dead, we better buy long dated bonds. But this sort of this global bond sell off that I think Scott Besant sees Japan's role to be absolutely pivotal in is completely, as you say, is square and centre of the whole operation. Because what this sort of this has been like a simmering concern among like tedious global macro pointy heads like us that at some point, like Japan will have to raise interest rates like Japanese interest rates were zero for like years and years and years and years. And Japanese government bonds basically had no yield on them whatsoever for like decades.

14:07And if Japan jacks up interest rates really hard, then its borrowing costs will go up, which is kind of bad news for Japan. But suddenly it means that investors around the world might say, oh, I'd like to own some of these Japanese government bonds. And maybe Japanese investors would say, why are we bothering buying treasuries when we can already get a decent rate on homegrown government bonds? And again, just sort of on the margins, that saps demand away from the US government bond market and pushes up US borrowing costs, which again, the US is really sensitive to. I guess another sort of important part of this little puzzle is that the Japanese and US authorities after that intervention on July the 31st said if they were to step in and support the yen again, they would use a super obscure facility at the Fed known as the Foreign and International Monetary Authority's repo facility, which is called FEMA, F-I-M-A.

15:07Now, this is kind of technical and, you know, you and I are not super familiar with this facility and it's not really designed for this sort of thing. But like, what is it and why is it preferable to both sides than just selling US government bonds? So this isn't something that I'm a specialist at, certainly. It's basically a way in which the Japanese can take their U.S. treasuries and without releasing ownership from them, they can kind of take them to a pawn shop with a W, get dollars back and sell those dollars and still be on the hook for whether treasury prices go up or down and no one has to sell a treasury.

15:47That's the important bit. No one has to sell a treasury, but you can release the dollars attached to the treasury by using this facility. yeah um so that's that's what's drawn a lot of attention to it it's it's what it's made people think oh okay this definitely is about the u.s treasury market after all yes right that's the thing it does indicate that the u.s is very sensitive to the possibility that japan could sell treasuries to try and fix this so the explanation um at the fed the word temporary comes up a lot it's a temporary backstop source of temporary dollar liquidity approved fema account holders can temporarily exchange their treasury securities for US dollars.

16:29But the important part of the Fed's own explanation of what this facility is, that it means that you can free up dollars into the system without sales of the securities in the open market. So again, this is just like to kind of market watchers, to the sort of wonks who care about this stuff, a massive red flag that says, please don't sell our treasuries. It would be really bad. So maybe we're all reading too much into it, but this is certainly taken as a bit of a tell. Yeah, it kind of looks like an advertisement because the proper deep nerds on this stuff go, would you use FEMA? You could use the private repo market and you could do it way more cheaper than actually using this particular facility, which is quite an expensive facility to use.

17:15So the fact that they're pointing towards with a big flashing sign, this facility just kind of looks like either there's something very weird coming down the pipe that we don't know about yet about the changes to it or that hey everyone it's all about US treasury market. Yeah and they're going to jack up the size of this thing aren't they so that it will make more dollars available to counterparties on a daily basis. So yeah I know it's deep in the weeds but this is just a kind of a little bit of a show and tell that yeah we're worried about people selling treasuries. But so if you look at the exchange rate, the dollar got as high as 164 yen.

17:54That was the point at which the US and Japan had a sense of humour failure, banded together and intervened. They bought yen. That got the exchange rate pretty much down to 155. That's a lot. 164 to 155 is a lot. However, we're now back at 159. That kind of means that Like about half of the effect of this intervention has already worn off. Not all of it, but about half of it. Like, why is that? I mean, I would say it's because you haven't actually addressed any underlying fundamentals, right? While we won't go step by step through 98, within eight days, it was completely unwound. And now we're just a few days and we're halfway through that already.

18:37It's looking kind of similar, maybe. Yeah. I think the thing that everyone's waiting for is when does Japan buckle on interest rates and just bite down on it, raise interest rates? Because, again, unless the sort of domestic situation is pulling in the same direction, it kind of doesn't work. But also from some of our reporting, what a few people have said to colleagues of ours is that the fact that this isn't properly coordinated, the fact that the Europeans aren't on board, they were only told afterwards, even though this was done in their currency, it undermines it so for big interventions to have any chance of working even temporarily really they've got to be proper global efforts and this is not that this is the US and Japan kind of freelancing in in the world's biggest market and maybe it will work but there's a few elements here that are lacking in terms of really kind of giving it all the ingredients for success So my bet is unless the Bank of Japan has a big change of heart and is able to raise interest rates very quickly, which again would be difficult politically, I think the market is going to be up for a fight on this with Scott Besson and the US.

19:50What do you reckon? It kind of looks like it's going to be testing him, right? So see what happens. Push a little weaker. You know, is there anything more coming? so a lot of drama here listeners if you have any further insight into what's going on or if you have strong views on whether or not this will work you know where to find us unhedged at ft.com but we're going to be back in just one sec with Long Short

20:21Right we are back for Long Short that part of the show where we go long a thing we love or short a thing we hate Toby Nangle from FT Alphaville What do you say? Well, I think I'd really like to go long some rain, please. Oh, my days. Will it ever rain? Apparently not. I mean, not in London anyway. Brian, our editor, hates it when Brits talk about the weather on the podcast. But suck it up, Brian. It just has not rained for like six weeks or something. We're desperate. Yeah, rain, please. I am long cheese. specifically I am long and I quote a blockchain backed cheese loan collateral program glorious story in fortune today piece saying that there is a bank vault in the hills of Italy that holds more than half a million wheels of Parmigiano Reggiano worth over 300 million euros anyway it's too hot the cheese is too hot I'm guessing it smells bad but also these cheese wheels are used as loan collateral for loans to local dairy farmers.

21:30This is all bad. I'm rooting for the cheese. I hope the cheese is okay. I think we all need for it to cool down. So listeners, send us your favourite cheese on hedged.ft.com. In the meantime, we will be back on Thursday. So please do a little rain dance. Stay cool and listen up then.