Why Did the US Treasury Support the Japanese Yen?

TL;DR

The US Treasury supported the Japanese yen partly to protect American borrowing costs as long-term Treasury yields reached their highest level since 2001. Japan’s low interest rates had helped finance a global carry trade estimated above $4 trillion, while the resulting weak yen raised Japanese import costs and exposed financial markets to a sudden, disruptive reversal.

Transcript

The United States government is now paying more to borrow money than it has in decades. And to understand why, we have to start somewhere strange with a currency operation the US hasn't attempted since 1998 and a photograph of a notepad. The notepad belonged to Treasury Secretary Scott Bass. And at a cabinet meeting last month, a Reuters photograph... Read More

Key Insights

• The yen’s prolonged weakness is driven largely by the interest-rate gap between the United States and Japan. US rates rose to around 3.75%, while the Bank of Japan held rates at zero for years and only recently raised them to 1%.
• A yen carry trade works by borrowing yen at very low cost, selling those yen for another currency, and investing the proceeds in higher-yielding assets. Examples in the transcript include US Treasuries, European bonds, Korean technology stocks, and Mexican bonds.
• The forward premium puzzle is the observation that low-interest currencies do not always appreciate enough to offset higher foreign yields, contrary to textbook expectations. The yen instead kept weakening while carry traders collected interest, allowing the strategy to remain profitable for years.
• The carry trade’s additional return can be understood as compensation for sudden reversal risk. When investors collectively unwind their positions, they must buy back yen, causing the currency to rise quickly and creating intense disruption across markets over a short period.
• The global yen-funded carry trade is estimated at more than $4 trillion, making it larger than India’s entire economy according to the transcript. This scale means many investments that appear unrelated to Japan may ultimately depend on inexpensive Japanese funding.
• A weak yen benefits large Japanese exporters but raises costs for Japanese households and businesses because Japan imports almost all of its oil, natural gas, and raw materials. Currency depreciation therefore translates into higher costs for energy and imported production inputs.
• The Katsu Curry index suggests that one dollar should buy about 62 yen, compared with an actual market rate of 159 yen. On that measure, the yen was undervalued by roughly 60%, while the Big Mac Index suggested about 80 yen per dollar.
• The US intervention marked its first effort to support the yen since 1998 and departed from decades of stated resistance to currency-market intervention. The description connects the decision to high American borrowing costs, 30-year Treasury yields at their highest since 2001, and Bessent’s rate bet.

Questions & Answers

Q: Why did the US Treasury support the Japanese yen?

The description argues that the intervention was not simply an act of support for Japan. Strengthening the yen could also protect American borrowing costs at a time when the US government was paying more to borrow than it had in decades and 30-year Treasury yields had reached their highest level since 2001. The operation also related to Scott Bessent’s large bet that US interest rates would fall.

Q: How does the Japanese yen carry trade work?

The yen carry trade begins when an investor borrows yen in Japan, where financing has been exceptionally inexpensive. The investor then sells the yen for dollars or another currency and purchases assets offering higher returns, such as US Treasuries, European bonds, Korean technology stocks, or Mexican bonds. The trade remains profitable when the yield difference exceeds financing costs and the yen does not rise enough to erase the gains.

Q: Why has the Japanese yen weakened against the US dollar?

The yen weakened primarily because of the large interest-rate difference between Japan and the United States. The Federal Reserve raised American rates to around 3.75% during 2022 and 2023, while the Bank of Japan kept its rate at zero for years and only recently raised it to 1%. Investors therefore had a strong incentive to sell low-yielding yen and hold higher-yielding foreign assets.

Q: What makes the yen carry trade dangerous?

The carry trade is dangerous because many investors can be exposed to the same reversal at once. If the yen begins rising, traders may rush to close their positions by selling foreign assets and buying back yen. That collective unwinding can make the yen rise even faster and produce severe market volatility, especially because the global trade is estimated to exceed $4 trillion.

Q: What is the forward premium puzzle in currency markets?

The forward premium puzzle describes the gap between textbook currency theory and observed market behavior. Theory says a low-interest currency should appreciate enough to cancel the additional return available in a higher-interest country. In practice, the yen weakened for years while investors continued collecting the interest difference. One explanation presented is that the apparent excess return compensates traders for the risk of a sudden, synchronized reversal.

Q: How does a weak yen affect people and businesses in Japan?

A weak yen can help large Japanese exporters because their overseas earnings become more valuable when converted into yen. However, it harms households and businesses that depend on imported goods. Japan imports almost all of its oil, natural gas, and raw materials, so depreciation raises energy and input costs. A Japanese restaurant, for example, may pay more for imported frying oil even as tourists enjoy greater purchasing power.

Q: What does the Katsu Curry index show about the yen?

The Katsu Curry index compares the price of pork cutlet curry at Coco Ichibanya to assess the yen’s relative value. According to the transcript, this measure suggests that one dollar should buy about 62 yen, while the market rate was 159 yen. That implies an undervaluation of roughly 60%. The Big Mac Index also indicated substantial undervaluation, although it suggested about 80 yen per dollar.

Q: Why was the US yen intervention historically unusual?

The operation was unusual because the US Treasury had not intervened to support the yen since 1998. For decades, the Treasury’s stated position was that major economies should let markets determine exchange rates and that intervention was generally an ineffective short-term measure. The action was especially notable because Japan also appeared on the Treasury’s July monitoring list for currency practices, although that report focused on efforts to weaken currencies.

Summary & Key Takeaways

• The yen weakened toward a 40-year low because US interest rates rose to around 3.75% while Japan maintained zero rates for years before raising them to 1%. This wide gap encouraged investors to borrow inexpensive yen, exchange it for other currencies, and purchase higher-yielding assets such as government bonds and technology stocks.

• The yen carry trade is estimated to exceed $4 trillion and supports investments far beyond Japan. It earns money while the yen remains weak, but a sudden yen appreciation can force many investors to unwind simultaneously. That reversal can rapidly disrupt markets because numerous leveraged positions are indirectly funded with Japanese currency.

• The US Treasury intervened to support the yen for the first time since 1998, reportedly selling euros rather than dollars. The description argues that protecting Japan was not the only objective. The operation also related to rising American borrowing costs, weakening dollar privileges, and Scott Bessent’s large bet that US interest rates would decline.