“Back Above 160 Yen” — Fed Tightening Exhausts Impact of U.S.-Japan FX Intervention, While Japanese Rate Hikes Threaten Public Finances

Japan’s massive FX intervention with U.S. effectively neutralized
Fed’s “focus on inflation” tightening signal triggers immediate market reaction
BOJ expected to accelerate rate hikes, amplifying fiscal management risks

Volatility in the Japanese yen has continued to intensify. Despite the Japanese government’s massive foreign-exchange market intervention in coordination with the United States, renewed signals of monetary tightening from the U.S. Federal Reserve and concerns over a widening U.S.-Japan interest-rate differential have once again brought the yen’s depreciation into sharp focus. Market participants expect the Bank of Japan to accelerate the pace of its policy-rate increases in response, but such a move risks further straining Japan’s public finances by driving up government bond yields and refinancing costs.

Joint U.S.-Japan Foreign-Exchange Market Intervention

According to an announcement by Japan’s Ministry of Finance on August 28, Japan conducted a total of approximately $87 billion in foreign-exchange market intervention over roughly one month, from July 30 through August 26. This marked the largest monthly intervention on record. Although the government did not disclose the individual intervention dates or daily amounts, market participants believe a substantial portion was deployed over the two days of July 30 and 31. Based on factors including the Bank of Japan’s projected current-account balances, Bloomberg estimated that approximately $53 billion was spent on July 30 and another $34 billion on July 31, bringing the two-day total to roughly $87 billion.

The United States notably joined efforts to support the yen on July 31. In a statement issued on August 3, Japan’s Ministry of Finance officially confirmed that it had “purchased yen in coordination with the U.S. Treasury Department on July 31.” It was the first joint U.S.-Japan market intervention to purchase yen since 1998, 28 years earlier. Japanese Finance Minister Satsuki Katayama explained that the intervention was conducted under the “Joint Statement by the U.S. and Japanese Finance Ministers” signed in September last year and was intended to address the yen’s recent excessive volatility and disorderly movements. She added that Japan remained in close communication with the U.S. government and would not hesitate to intervene again if necessary. Neither country, however, disclosed the actual scale of the U.S. intervention or the details of their respective transactions.

Yen Returns to Starting Point Within a Month

At the time, the United States concluded that uncertainty surrounding the yen could threaten U.S. markets. According to Bloomberg on August 29, U.S. Treasury Secretary Scott Bessent wrote in an August 27 letter to Democratic Senator Elizabeth Warren that “Japan is a major holder of U.S. Treasury securities,” adding that “a disorderly yen market could trigger forced position liquidations, which could destabilize global markets and ultimately raise borrowing costs for American households and businesses.” The letter was a response to Warren, the ranking Democrat on the Senate Banking Committee, who had requested the basis and related analysis for the use of the Treasury Department’s Exchange Stabilization Fund in the joint U.S.-Japan foreign-exchange market intervention in August.

The problem is that the yen failed to stabilize fully despite the massive market intervention. The dollar-yen exchange rate, which had climbed to the upper 162-yen range at the time of the U.S.-Japan intervention in late July, plunged to around 155 yen immediately afterward. It began rising again in mid-August, however, and ultimately returned to the 160-yen range by the end of the month. Specifically, the exchange rate rose as high as 160.21 yen per dollar during intraday trading on August 28 and remained at 160.20 yen on August 30. In effect, much of the yen’s appreciation generated by the joint intervention had been reversed.

Table 1. Joint U.S.-Japan Foreign-Exchange Market Intervention and Yen Exchange-Rate Movements

Fed Signals Potential Rate Hike

The latest exchange-rate uncertainty is widely attributed to the Federal Reserve’s increasingly pronounced tightening stance. At the Jackson Hole Economic Policy Symposium on August 28, Fed Chair Kevin Warsh said of the recent inflation environment, “We need to be confident that underlying inflation is moving toward our target at a clear and sufficient pace,” adding, “If it is not, we still have work to do.” He noted that recent summer inflation data had been better than expected but stressed that “it cannot be said that the underlying trend has improved meaningfully.” He also pointed out that the Fed’s preferred personal consumption expenditures price index had risen 3.7% over the preceding 12 months and 4.1% on a six-month basis, arguing that “the Fed’s primary focus at present must be on inflation.”

Markets interpreted the remarks as a hawkish signal that left open the possibility of a future policy-rate increase. According to Reuters, the probability of a September rate increase implied by interest-rate futures surged from around 35% before the speech to approximately 60% afterward. The yield on the two-year U.S. Treasury note climbed 11 basis points to 4.34%, its highest level in roughly a month, while the U.S. Dollar Index, which measures the currency against six major peers, advanced 0.6% from the previous day to 99.66. As expectations of a policy-rate increase enhanced the investment appeal of dollar-denominated assets, including U.S. Treasury securities, the dollar began facing renewed upward pressure.

Upward Pressure on Japanese Policy Rates

An increase in U.S. policy rates would widen the interest-rate differential between the United States and Japan, intensifying the yen’s depreciation. This explains the growing expectations that the Bank of Japan will also accelerate its rate-hiking cycle. According to Bloomberg, the probability of a BOJ rate increase in September implied by the overnight index swap market stood at approximately 85% as of August 27. Market pricing compiled by The Wall Street Journal likewise reflected a probability approaching 90%. Some analysts also expect the BOJ to shorten the interval between rate increases, predicting consecutive hikes at its September and December monetary policy meetings. Given that the previous rate increase came in June, this would effectively double the pace of the BOJ’s rate-hiking cycle from the approximately six-month intervals it has maintained to date.

BOJ officials have also issued a series of remarks emphasizing the need for further tightening. At a meeting with business leaders in Saitama on August 27, BOJ Deputy Governor Ryozo Himino said, “We need to be more alert than before to the risk that inflation could rise more than expected,” adding that the central bank would “continue raising the policy rate to adjust the degree of monetary accommodation.” He further stressed that “preventing a situation in which delayed rate hikes exacerbate inflation and subsequently necessitate abrupt rate increases is ultimately desirable for small and midsized businesses, mortgage borrowers and public finances.” BOJ Governor Kazuo Ueda likewise warned at a press conference following the central bank’s July monetary policy meeting that “we must monitor more closely than before the risk that underlying inflation could exceed the 2% price-stability target,” adding that “an excessive rise in underlying inflation could adversely affect the economy.”

Sharp Increase in Fiscal Burden

The problem is that monetary tightening could rapidly increase the Japanese government’s fiscal burden. Under its prolonged ultra-low-rate policy, Japan issued vast quantities of government bonds at low interest rates. According to Japan’s Ministry of Finance, the outstanding balance of general government bonds is projected to reach approximately $7.13 trillion by the end of fiscal 2026. If interest rates rise under these conditions, the government’s interest burden will increase substantially as maturing low-yield bonds are refinanced with new debt carrying higher rates. Japan’s interest payments for fiscal 2026 have already risen to approximately $80.9 billion, up by roughly $15.6 billion from the original fiscal 2025 budget of approximately $65.4 billion. The ministry explained that approximately $9.34 billion of that increase was attributable to the higher cost of refinancing existing government debt.

This trend could impose additional pressure on Japan’s public finances, which are already burdened by tax-cut policies. Prime Minister Sanae Takaichi’s Cabinet is currently pursuing a plan to temporarily reduce the consumption-tax rate on food from the existing 8% to 1% for two years. The measure would fulfill a pledge made by Takaichi during the February House of Representatives election and is intended to alleviate the burden on households from persistently high inflation. The problem is that it remains unclear how the government would offset the resulting revenue shortfall. The Daiwa Institute of Research, a Japanese think tank, estimated that lowering the consumption-tax rate on food from 8% to 1% would reduce Japan’s annual tax revenue by approximately $27.4 billion, while increasing gross domestic product by only about $1.87 billion. This suggests that the economic stimulus generated by the tax cut alone would be insufficient to compensate for the loss of tax revenue. Although Takaichi has said that the government will not rely on additional deficit-financing bond issuance, no specific alternative source of funding has yet been presented.