Yen Strength Lifts the Won in Tandem; Carry-Trade Unwind Concerns Persist
The exchange rate fell for a second straight day, with the won-dollar rate dropping to 1,339 won. This reflected the yen-dollar rate stabilizing around 153 yen, with yen strength weakening the dollar, which in turn fed through to won strength. Behind this lies Japan's largest-ever foreign exchange market intervention. In August, Japan deployed $98.6 billion to defend the yen, and in the process is confirmed to have sold US Treasuries it held, with Bloomberg reporting that Japan's holdings of foreign securities fell below $1 trillion.
The structure that has sustained the yen carry trade — Japan keeping rates low while defending yen weakness through Treasury sales — is now facing a shift, as the market is pricing in a 98%, effectively near-certain, probability of a Bank of Japan rate hike this month. A rate hike could trigger a carry-trade unwind as yen funds flow back to Japan, raising concerns of selling pressure on risk assets worldwide; however, many in the brokerage industry believe that, having learned from 2024, the market is already prepared and unlikely to see a shock on the scale of the past.
The variable to watch is Treasury Secretary Bessent's bond purchases. The Treasury Department has decided to buy back a portion of the oversupplied Treasuries in the market to curb a sharp rise in yields, with purchases set to begin from September 9 starting tonight. The market expects purchases in the range of $5-6 billion, while Bessent mentioned at least $4 billion, noting that the Treasury account holds about $1 trillion, and stressed that this is not quantitative easing.
Bessent also issued a warning to traders betting on yen weakness, saying 'I am the house now,' asserting that market control rests with him. The hosts, however, noted that such remarks could be an exaggerated show of bravado, assessing it as an attempt to manage the situation through rhetoric rather than actual firepower to instill market confidence. Ultimately, as long as the US keeps a close eye on Treasuries, Japan will have little choice but to accelerate the pace of rate hikes, and there was discussion that the typical six-month interval between hikes could narrow to three months, raising the possibility of another hike within the year.