The Japanese yen has experienced a significant decline, reaching a 40-year low against the US dollar. This drop has heightened speculation regarding potential government intervention by Japan, which could have far-reaching impacts on US stocks, the Treasury market, and the global economy at large. The yen’s current state marks its most significant decline since 1986, largely attributed to shifts in expectations surrounding US interest rates amid geopolitical tensions, particularly the ongoing conflict with Iran.
Efforts earlier this year by the Japanese government to bolster the yen proved ineffective, and market analysts are now anticipating another intervention attempt as the currency continues to plummet. Traders are increasingly confident that the US Federal Reserve will either maintain its interest rates or potentially increase them in response to inflation concerns exacerbated by the US-Israeli war with Iran. This outlook has contributed to the dollar’s resurgence, with the US dollar index up 3% this year, rebounding from a previous decline.
According to Lee Hardman, a senior currency economist at MUFG, the energy price shock from the US-Iran conflict has been a critical factor in the yen’s weakness, compounded by a more aggressive stance taken by the Fed on interest rates. National monetary policies typically determine currency fluctuations, and while the Bank of Japan raised its benchmark interest rate to 1% in June—the highest rate since the 1990s—this still lags behind the Fed’s range of 3.5% to 3.75%. This disparity in interest rates is prompting capital flowed into the US market, further strengthening the dollar at the yen’s expense.
The Supreme Court has reinforced the central bank’s independence by ruling that President Donald Trump cannot dismiss Fed Governor Lisa Cook without proving wrongdoing. This bolstering of the Fed’s authority, alongside its firm handling of inflation, has added further support to the dollar.
Recent months have seen the yen consistently hit low points against the dollar, notably marking a transformation from levels seen in 2024. Japan has historically maintained low interest rates—spanning zero to negative rates through the 2000s and 2010s—in an effort to stimulate growth and fend off deflation after a prolonged recession in the 1990s. The BOJ initiated rate increases in 2024 as inflation exceeded its 2% target, yet the yen has continued to decline as Japan’s rates remain low relative to global benchmarks.
A continued depreciation of the yen, juxtaposed with persistent inflation, raises concerns about a potential economic crisis in Japan. As a nation heavily reliant on imports for food and energy—particularly in light of the oil price surge following the US-Iran war—the implications of a weaker yen include heightened import costs and increased financial strain on households. Chris Turner from ING emphasizes that officials are acutely aware of how a weakened yen threatens rising import prices and poses challenges for the populace.
In response to the weakening currency, the Japanese government could engage in intervention by selling US dollars or dollar-denominated assets to purchase yen. Market analysts have indicated that such intervention could materialize as early as this weekend. A notable appreciation in the yen could, in turn, exert downward pressure on the dollar and Treasury yields.
Historically, Japan’s market interventions have been limited in scale, with a noteworthy intervention occurring earlier this year involving the sale of about $70 billion in dollar assets—though this had minimal impact on US markets and did not address fundamental problems.
Should Japan offload more of its Treasury holdings, immediate effects might see bond yields rise, as yields typically increase when bond prices fall. However, the impact is expected to remain modest considering the size of the US Treasury market.
For stock markets, changes in the yen could have significant ramifications. A common trading strategy involves borrowing yen to invest in US equities, leveraging Japan’s low interest rates. A sudden rebound in the yen, spurred by government action and paired with ongoing rate hikes from the BOJ, could render borrowing more expensive. This scenario might lead traders to liquidate stock positions to cover their loans, raising concerns about potential negative cascades in equity markets.
Any significant intervention, especially if conducted in collaboration with the US Treasury, could provoke a substantial unwinding of the “carry trade,” which could drastically affect US equities, particularly in sectors like technology that have shown volatility in response to rising interest rates.
The currency dynamics underline broader trends affecting the US stock market, where the vast majority of American retirement savings are tied up. As trading increasingly becomes influenced by algorithms, shifts in currency markets carry considerable weight for overall market performance. This period reflects substantial volatility and unpredictability, challenging previous assumptions held at the beginning of the year regarding the relationship between the yen and the dollar.
