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It’s not every day you see the world’s top economies intervening in the currency market. But that’s exactly what happened over the past week.
Trading in currency markets – also called foreign exchange (or forex) – dwarfs everything else. The daily volume of currency trading reached $9.6 trillion last year. That easily surpasses daily volumes in stocks and fixed income.
It’s a massive market where currency movements can play a big role in boosting or suppressing a nation’s economy.
It’s not uncommon to see interventions in emerging market countries. But it’s much rarer to see top economies taking action.
But that’s exactly what happened when officials intervened to support the Japanese yen.
The moves came after a period of yen weakness, offering one explanation for the action. But another underlying reason reveals the precarious situation underneath it all.
And that should make you concerned…
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Intervention in the yen isn’t anything new. Speculation had been building for weeks that something was in the making because the yen had weakened to the worst levels against the U.S. dollar since 1986.
While a weak yen is a boost for Japan’s export-oriented economy, the falling currency presents other issues.
For one, Japan isn’t a resource-rich nation. The country must import much of its oil and gas needs. A weak yen makes energy imports more expensive.
There’s also concern that the falling yen signals trouble with the country’s finances. That’s why we saw bond prices fall and yields rise.
Intervention can take a couple of forms. Sometimes it’s tough talk and threats from public officials to scare markets. In other instances, a country’s central bank can boost interest rates to support a currency.
The most aggressive form of intervention is when officials make direct purchases of a currency to drive up its value.
That’s what happened with the yen last week. But the biggest surprise of all was that Japan didn’t act alone.
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Japanese officials weren’t the only ones to intervene in the yen. For the first time in nearly three decades, the U.S. joined Japan to support the yen.
Japan spent an estimated $36 billion in a single session to strengthen the yen.
While the amount spent by the U.S. isn’t confirmed, a photographer captured a note written by Treasury Secretary Scott Bessent at a cabinet meeting to “buy Japanese Yen (JPY) $5-10 bil.”
The U.S.’s motivation for joining the effort is cause for concern.
Japan remains the single largest foreign holder of U.S. Treasury securities to the tune of about $1.19 trillion. Japan could have sold Treasurys (and thus dollars) as part of its attempt to strengthen the yen.
If it did, the selling pressure could push bond prices lower and rates higher. (Remember that interest rates rise when bond prices are falling.)
Interest rates across the yield curve are already under pressure. The 30-year Treasury yield recently jumped to 5.2%, the highest level in 19 years. Japan’s selling could have pushed rates higher still.
The speculation is that the U.S. became directly involved to prevent Japan from dumping Treasurys. It shows growing concerns of rising interest rates coupled with the dire state of public finances.
Rising rates can impact everything from the economy to bond allocations in investor portfolios. Actions to prevent Japan from selling Treasuries show that U.S. officials’ fears about high rates are growing.
And that’s something that all investors should be paying close attention to.
We’ve talked before about the stock market’s steep valuations. Many of the big stocks – like the Magnificent 7 – rely on low rates to keep borrowing costs low. Not to mention, higher rates make options like bonds and CDs more attractive, pulling investor funds from the stock market.
If the interest rate situation tips the wrong way, this rally could come to an abrupt halt. So this is one more reminder to play this market carefully…
Regards,
Larry Benedict
Editor, Trading With Larry Benedict
Reading Trading With Larry Benedict will allow you to take a look into the mind of one of the market’s greatest traders. You’ll be able to recognize and take advantage of trends in the market in no time.
