Wall Street believes "If Japan doesn't raise interest rates, any intervention is useless"

By: Long Yue, Wallstreet CN

The US and Japan joined forces to spend nearly 100 billion USD intervening in the yen, but the market has voted with action: the yen's rebound is rapidly fading.

On August 3, the Japanese Ministry of Finance confirmed it had joined hands with the US Treasury Department to act, deploying nearly 100 billion USD to buy yen within two days, setting a historical record, and warned it would not hesitate to act again if necessary. This is the first time the US and Japan have joined hands to intervene in the forex market since the 2011 Fukushima nuclear disaster.

After the news, the yen once strengthened significantly. However, the sustainability of the rebound is questionable; the yen has quickly fallen back more than 200 points from the high after intervention, with the price movement almost identical to the path after the intervention on April 30 this year—surging high and then quickly reversed by the market.

The core of the problem lies not in the intervention itself, but in the Bank of Japan. As long as the US-Japan interest rate differential does not narrow, there is no sufficient reason for the yen to rebound. Goldman Sachs economists' current baseline expectation is: the Bank of Japan's next rate hike will be in January 2027, meaning the short-end interest rate differential of over 200 basis points between the US and Japan will be maintained for the long term, "the yen is most likely to remain weak"—what the intervention bought is merely time.

In other words, as long as the Bank of Japan does not raise interest rates, intervention is fighting an unwinnable war with limited bullets. On August 3, the US Dollar Index closed almost flat for the day, the yen closed at 156.99, rising only slightly by 0.3%.

Why Is Intervention Ineffective?

The scale of this round of intervention is unprecedented. According to Bank of Japan account data, the single-day intervention scale on July 31 (Thursday) was about 8.45 trillion yen (about 53 billion USD), setting the historical record for the largest single-day intervention; on Friday, it acted again with about 5.3 trillion yen (about 33 billion USD). The two days totaled nearly 100 billion USD. After the intervention, USD/JPY once fell to 155.20, but then rebounded more than 200 points. Previously, since September 2022, the Japanese Ministry of Finance has cumulatively intervened over 255 billion USD, but has always failed to stop the long-term depreciation trend of the yen.

Although this scale is record-breaking, the Goldman Sachs research team (led by Mike Cahill) pointed out in the latest report, "Market reaction is in the lower range of historical interventions, indicating that when yen depreciation broadly aligns with macro and market fundamentals, the marginal effect of intervention is diminishing—although it still has some effect."

Why is intervention difficult to be effective? Analysis believes that the fundamental logic of yen depreciation is the interest rate differential.

The US federal funds rate is far higher than the Bank of Japan policy rate, and the interest rate differential of over 200 basis points between the two means that shorting the yen and holding USD assets makes money every day. As long as this interest rate differential exists, carry trades have the motivation to continue.

Bloomberg columnist John Authers pointed out that the Japanese Ministry of Finance's interventions are becoming more frequent, which precisely indicates that the effect of each intervention is getting worse. The market knows the Ministry of Finance's ammunition is limited, also knows Japan's fiscal situation is poor, and knows even more that the only means to truly reverse the yen's decline—significant rate hikes, calculated by some to require a 100 basis point hike—is almost impossible to happen in the foreseeable future.

Why Does the Bank of Japan Dare Not Raise Interest Rates?

Intervention can buy time, but cannot change direction. The Bank of Japan is the real variable.

The Bank of Japan's current policy rate is 1%, the highest since 1995, but within hours after last week's intervention occurred, the Bank of Japan chose to stay put and did not raise interest rates.

Jesper Koll, a long-term investment banker based in Tokyo, asked directly:

Bank of Japan Governor Kazuo Ueda confidently told us that he expects Japan's inflation to re-accelerate to above 2% in the second half of the fiscal year, but he subsequently chose not to act. So, why exactly are you not raising interest rates? Is it because Japan's financial system is too fragile, and accelerating rate hikes will trigger a banking crisis?

The answer is almost on the table. In the Japanese government bond market, more than half of the debt is already held by the Bank of Japan—because there are no other sufficient buyers. Once interest rates rise rapidly, Japanese government bond prices will fall sharply, and the entire fiscal architecture faces the risk of collapse.

Former Goldman Sachs FX strategist, now Brookings Institution fellow Robin Brooks put it more bluntly:

The yen is falling because Japan's high public debt prevents the country from allowing yields to rise freely.

He believes that yen depreciation is essentially "a symptom of a concealed debt crisis".

With bonds suppressed, the yen becomes the most direct symptom of a concealed debt crisis.

Without Rate Hikes, Everything Is Temporary

Goldman Sachs' overall conclusion is: in the short term, the asymmetric risk of USD/JPY points to further downside; if the exchange rate breaks through 158 again, authorities are likely to act again; technically, once 155 is effectively broken below, the next important support is near 152.

But in the medium term, the Goldman Sachs research team (led by Mike Cahill) believes,

Unless there is a substantive change in the policy mix or global growth prospects, encouraging capital repatriation (repatriation) will be the most powerful long-term policy tool affecting the yen exchange rate.

The implication is that intervention and gradual rate hikes are not enough to sustainably strengthen the yen.

Goldman Sachs Global Head of FX Options Trading Praneet Shah also warned, "In the medium term, the policy background of loose money + loose fiscal policy remains bearish for the yen, unless Japan truly raises policy interest rates and achieves substantive foreign direct investment inflows. In addition, as intervention reserves are consumed, Japan's ammunition in exchange rate defense will decrease in the future, possibly accumulating risks for larger-scale yen depreciation."

Long-term Tokyo-based investment banker Jesper Koll, although considering himself a Japan economic optimist, also admitted: "Yen weakness is still the high-probability path. The Bank of Japan staying put is driven by concerns about the secondary banking system; and new fiscal policy almost inevitably leads to inflation in the end, risks remain asymmetrically biased towards a weaker yen."

In other words, intervention can buy time, but cannot buy trends. If the Bank of Japan does not raise interest rates, any intervention will eventually be digested by the market.

The Biggest Tail Risk: Unwind of Carry Trades

The reason why yen intervention touches the nerves of the global market also has a deeper reason: the massive scale of yen carry trades.

In the past five years, the strategy of borrowing low-interest yen and investing in high-yield assets has even exceeded the total return of the S&P 500. The premise of this trade is that the yen depreciates slowly and predictably.

Once the yen appreciates rapidly, carry trades are forced to close positions, which will impact global risk assets. Two years ago (August 2024), carry trades were once partially closed in a "chaotic manner", causing severe volatility in the global market.

This round of intervention has already caused carry trades to be clearly shaken out from the previously stable upward trend.

Goldman Sachs trader Jia Wen Tuea hinted that this is also one of the realistic logics for US participation in intervention: "Japan is the largest foreign holder of US Treasury bonds. If Japan intervenes alone, it needs to sell US Treasuries to exchange for USD to buy yen, pushing up US yields—this is also a trouble for Washington."

Goldman Sachs: Next Rate Hike May Be in January 2027

Goldman Sachs economists judge against the trend: inflation data is not enough to support the Bank of Japan raising interest rates in September, maintaining the baseline forecast—the next rate hike will be in January 2027.

If this forecast comes true, it means the US-Japan interest rate differential will maintain the status quo for a considerable period, the logic of carry trades still holds, and the structural depreciation pressure on the yen will not disappear.

The more direct consequence is: the US Treasury Department's joint intervention this time will face significant losses—the yen bought with real money may depreciate significantly as the yen weakens again.

Koll summarized that although he is optimistic about the Japanese economy, he also admitted "the yen is most likely to remain weak", risks remain asymmetrically biased towards further yen depreciation.