The yen is once again approaching 160, but the bears are afraid to move? Goldman Sachs dismantles Japan's trillion-dollar “intervention ammunition”

The Zhitong Finance App learned that Goldman Sachs said that Japan has enough cash on hand to support several rounds of Japanese intervention operations on a historic scale similar to last month, and that the Japanese authorities can also obtain financial support from the Federal Reserve. Goldman Sachs estimates that of Japan's foreign exchange reserves of about $1 trillion, about $200 billion is held in cash or highly liquid equivalents—roughly the size of Japan's July intervention.

Goldman Sachs research strategist Karen Fishman said on Wednesday: “They have sufficient resources to carry out a few more rounds of transactions at the record level we have just seen.”

“In reality, it is unlikely that they will use all of their capital, but I think this just shows that they are fully capable of continuing to interfere in the market if they want to,” Fishman said.

The Federal Reserve's FIMA Tool: A Theoretical “Infinite Backer”

In addition to its own cash reserves, Goldman Sachs also specifically mentioned the Federal Reserve's Foreign and International Monetary Authority Repurchase Facility (FIMA) tool. This mechanism allows central banks to use their US Treasury bonds as collateral to borrow dollar cash from the Federal Reserve, so as to quickly raise the dollar funds needed for intervention without having to sell US bonds in the secondary market.

Fishman explained that with this tool, Japan can theoretically convert all of its foreign exchange reserves of about 1 trillion US dollars (including non-cash US Treasury bonds) into usable liquid capital. Japan's Ministry of Finance has previously publicly stated that it plans to use this mechanism as appropriate.

Fishman said this statement “has some credibility,” given that the United States joined forces with Japan to intervene in the yen exchange rate for the first time since 1998. Furthermore, after the 2011 earthquake, Japan and the US also coordinated actions with other G7 members to curb the appreciation of the yen.

This outlook has significantly changed market sentiment. Pranit Shah, head of foreign exchange options trading at Goldman Sachs, said that after customers learned last week that the Japanese authorities could use the Federal Reserve mechanism to mobilize trillions of dollars in reserves to intervene, the bullish sentiment towards the yen heated up significantly.

The results of the historic intervention subsided, and the yen recovered half of the increase

Looking back at last month, Japan and the US jointly interfered in the foreign exchange market for the first time since 1998. The Japanese authorities spent up to 85 billion US dollars in two trading days. This scale is second only to the intervention record after the Fukushima nuclear disaster in 2011.

Prior to the joint intervention of the US and Japan, the yen exchange rate fell to 164 yen to the US dollar, hovering near its lowest level in nearly 40 years. The intervention once successfully boosted the yen exchange rate to the 158 range, breaking through the 200-day moving average. However, the effects of the intervention are fading: on Wednesday, the exchange rate of the yen fell back to around the key 160 mark against the US dollar, taking back about half of the gains brought about by the intervention.

Fishman said the intervention “wasn't a sustainable solution... it only bought some time in the end.” Fishman also said that Japan's separate intervention in April and May of this year was a testament to the past — after a brief rise, the yen once again reached its lowest point in 40 years within a few months.

Triggers for Future Interventions: Spreads, Data, and Central Bank Meetings

Shah said that whether the Japanese authorities will interfere in the foreign exchange market again may depend on interest spreads between Japan and the US, and interest spreads are still the main driving factor for the depreciation of the yen.

Late on Wednesday, the 10-year US Treasury yield was 4.690%, while the 10-year Japanese Treasury yield was 2.839%, which gave investors considerable impetus to hold US Treasury bonds.

On the Japanese side, the market currently anticipates a 65% chance that the Bank of Japan will raise interest rates by 25 basis points in September, and that interest rates will be tightened by about 40 basis points before the end of the year. Fishman said, “If they don't raise interest rates in September, it will once again put downward pressure on the yen.” Shah, on the other hand, pointed out that the Bank of Japan needs to raise interest rates faster than market expectations in order to change the arbitrage pattern that has caused the yen to depreciate by about 45% in the past five years.

On the US side, Shah said that weak economic data may ease the pressure on the yen — this will weaken the reasons for the Federal Reserve to raise interest rates further, and revive market expectations for another intervention by Japan. He specifically mentioned the July 2024 scenario: the Bank of Japan and the Ministry of Finance carried out the most effective round of intervention at the time, coinciding with the US CPI data falling short of expectations, and the non-agricultural data fell short of expectations a few days later.

He said, “If the US economic data is unexpectedly weak, I think the market will start raising expectations for subsequent intervention later this week.”

The US inflation data released on Wednesday was in line with expectations. The data showed that the consumer price index rose 0.1% in July, in line with general market expectations; the annualized inflation rate fell to 3.4% from 3.5% in June. US Treasury yields declined somewhat after the report was released.

All in all, Goldman Sachs believes that Japan still has sufficient “ammunition” for foreign exchange intervention — whether it's a $200 billion cash reserve or the Federal Reserve's FIMA tool, which theoretically mobilizes all trillion US dollars of reserves, provides strong policy options for the Japanese authorities. However, in the end, intervention is only an expedient measure; the long-term direction of the yen exchange rate will still depend on the evolution of interest spreads between the US and Japan and the actual trajectory of the monetary policies of the two countries. The Bank of Japan's policy meeting in September will be a key point for the market to determine whether this round of yen market can continue.

Options pricing shows that traders are still afraid that the yen will rise again, and this concern itself may dampen the new sell-off. Shah said that the high premium for short-term yen bullish options indicates that the market is still wary of a possible sudden jump in the yen, which makes investors unwilling to short the yen when it falls back to around 160.

He said, “If the spot exchange rate is really close to 160 and the market has fully priced the risk of a sharp pullback, then continuing to sell yen will face a real risk.”