- America moves to support the sliding Japanese yen
- US Treasury Secretary Scott Bessent is likely keen to prevent Tokyo from selling its large holdings of US government debt
- Bank of Japan’s unappealing policy options are a warning to Western central bankers
- BoJ may need to raise interest rates to make the yen’s gains stick
- Why equity investors, bond vigilantes and currency traders will be watching closely
“Monty Python’s ‘Money Song’ feels a bit dated now, given its references to what it terms the lure of the lira and the romance of the ruble, let alone the glitter and glory of the guinea, but it gets one thing right in that it does not mention the Japanese yen at all,” says AJ Bell investment director Russ Mould.
“Such is the currency’s decline this decade that both Washington and Tokyo are stepping in to support it, although America’s involvement is unlikely to be for altruistic reasons. Treasury Secretary Scott Bessent will be more worried about the prospect of Japan selling some of its huge US government bond holdings than the debt and inflation woes of Prime Minister Sanae Takaichi.
“Late last month the yen slid to its lowest levels against the dollar since 1990, at almost ¥164.
Source: LSEG Refinitiv data
“The currency took fright from PM Takaichi’s cut on consumption tax on food for two years from 1 April 2027, and how this could further pressure Japan’s already stretched sovereign finances, where the government debt-to-GDP ratio is around 250%.
“One worry is that the Bank of Japan will have to revert to Quantitative Easing and start buying Japanese Government Bonds (JGBs) hand over fist in an effort to rein in Tokyo’s borrowing costs, which are rising relentlessly in response to lofty supply and another ongoing concern of inflation.
“Japanese 10-year yields stand at their highest mark since 1996, and the 30-year paper, which has a shorter trading history, offers its highest yield ever. Both trends only aggravate the weakness of Japan’s sovereign finances.
Source: LSEG Refinitiv data
“Governor Kazuo Ueda and his colleagues face criticism that they are being too timid and should be raising interest rates faster to head off inflation. Five interest rate increases in two years still leave the headline main policy rate at just 1.00%, a level exceeded by the Japanese inflation rate in each and every month since early 2022.
Source: LSEG Refinitiv data
“Ueda’s caution may reflect worries that draconian rate rises will increase debt servicing costs and strengthen the yen to the point where exports take a hit and the economy slows down, or even tips into recession. On the other hand, the weak yen makes imports more expensive, to stoke inflation, and is giving owners of JGBs ulcers, with the result that JGB yields are going up anyway.
“In this respect, the Bank of Japan may be trapped between two unappealing policy options. But if Tokyo really was worried about defending the yen, then getting Ueda and the BoJ to act in a decisive manner would be the easiest way to do it.
“Instead, the USA is stepping in to help, but its motives are not wholly charitable.
“If Japan were to intervene unilaterally in the currency markets, one way to do so would be to sell some of its enormous holdings of US government bonds, or Treasuries.
“Japan owns more than $1.1 trillion of US sovereign debt, to make it easily the largest foreign individual holder. A fire sale would increase yields on the paper and further pressure America’s increasingly fragile finances, where sovereign debt is careering toward the $40 trillion market and the annual interest bill gobbles up a fifth of tax receipts.
Source: US Treasury
“Any economic slowdown, or stock market wobble, in the USA would reduce Washington’s tax take and increase welfare spending, while higher bond yields would chew up more precious income at a time when the war in the Middle East means defence spending is on the march once more.
“Bond vigilantes are getting edgy Stateside, judging by how 30-year Treasury yields stand at their highest mark since 2007 and 10-year yields are nudging their way back toward 5.00%, a threshold also last crossed in 2007.
Source: LSEG Refinitiv data
“This helps to explain why US Treasury Secretary Bessent is taking decisive action and doing so in a manner that may please Eric Idle and the Pythons, given their claim in the ‘Money Song’ that, ‘Everyone must hanker for the butchness of a banker.’
“Whether this appeases currency markets remains to be seen, but equity investors will be watching too, as some will remember how a sudden surge in the yen in August 2024 prompted a squall across global share prices.
“The yen had long been a key source of global liquidity, as major market players shorted it, borrowed against it, and used that money to back long risk assets around the globe.
“Summer 2024’s unexpected yen rally forced the closure of massive short positions against it, drove the currency higher still and forced yet more liquidation by the shorts, who had to sell their long positions elsewhere, such as in global equities, that they had funded with cheap yen.
Source: LSEG Refinitiv data
“That storm abated quickly but equity investors will be on alert all the same, even if global equities took 2022’s temporary, and gradual, rally in the yen in their stride.”
