So much for US Treasury Secretary Scott Bessent’s claim that he had asymmetric information about the Bank of Japan’s (BOJ) interest rate policy intentions. So much, too, for his warning to currency traders not to bet against the Japanese yen, claiming that he was now the house.
Yesterday, at its interest rate meeting, far from surprising markets with a more aggressive monetary policy stance, the BOJ confirmed the market’s view that it is a central bank that can be counted on to do too little too late. This does not bode well for the Japanese yen and by extension the US Treasury bond market.
It is not for altruistic reasons that Bessent wants the yen to strengthen. Rather, it is because he fears the consequences that a further slide in the yen would have for the US Treasury bond market. A further slide in the yen most likely would induce the Japanese authorities to sell at least part of their $1.2 trillion in US Treasury bond holdings to help prop up the yen. This is the last thing Bessent needs when he is already having difficulty financing the US government’s $2 trillion budget deficit and rolling over more than $3 trillion in maturing debt each quarter. Underlining Bessent’s difficulties has been the spike in US long-term bond yields to their highest level in the past 20 years, with the 10-year Treasury bond yield now having crossed the psychologically important 5 percent threshold.
As an experienced hedge fund currency trader, Bessent knows full well that exchange market intervention has no chance of long-run success unless it is backed by appropriate macroeconomic policy measures. If he had any doubts on this score, they would have been dispelled by the very weak bounce in the yen over the past month despite some $100 billion in joint Japanese-US foreign exchange market intervention. For that reason, he has been exerting considerable pressure on Sanae Takaichi, Japan’s new prime minister, to back off her fiscal stimulus proposals and on the BOJ to hike interest rates at a more rapid rate than that to which it is accustomed.
It would be an understatement to say that yesterday the BOJ failed to meet Bessent’s expectations. While it did hike interest rates by 25 basis points and expressed concern about inflation, it did so with two board members, both appointed by Takaichi, voting against the decision. This must cast doubt on the BOJ adopting an aggressive interest rate policy anytime soon.
The BOJ’s timid interest rate policy decision is even more disappointing coming as it does on the immediate heels of bold Federal Reserve policy action. This week Fed Chair Kevin Warsh had the courage to hike the Fed’s interest rate by 25 basis points on the eve of November’s midterm US congressional election, despite vociferous calls by Trump for interest rate cuts. Warsh also intimated that the Fed would likely need to raise interest rates again before year-end. This means the US will continue to have a short-term interest rate 2.5 percentage points higher than Japan for the foreseeable future. That must be expected to continue weighing on the yen by keeping the so-called Japanese yen carry trade going, whereby investors borrow in yen at low interest rates to invest in higher-yielding assets abroad.
A further reason to be concerned about the BOJ’s timidity is that it is occurring against the backdrop of the sorry state of Japan’s public finances and considerable weakness in the Japanese government bond market. At a time when Japan’s public debt is at around 230 percent of GDP, Takaichi shows no sign of backing off her proposed fiscal policy stimulus. Meanwhile, Japanese government bond yields have spiked to multi-decade highs. The BOJ’s relative policy passivity could heighten market fears that Japan might try to inflate its way out of its debt problem.
All this suggests that barring a shift in Japan’s monetary policy and fiscal policy stance, we must expect the Japanese yen to slide and its government bond yields to rise to new record levels. This would seem to be the last thing that Bessent needs at a time of considerable stress in several of the world’s major government bond markets, including our own.