WSJ: "Dollar Supply for Yen Defense Runs Counter to Fed Tightening"

Use of the Fed’s Emergency Liquidity Facility

The Trump administration in the United States has come under criticism for using the Federal Reserve's dollar lending facility for foreign central banks to defend the value of the Japanese yen, which may increase liquidity within the U.S. and undermine the effects of monetary tightening.

U.S. Federal Reserve. Yonhap News

The Wall Street Journal (WSJ) reported on the 6th (local time) regarding the joint U.S.-Japan intervention to purchase yen, saying, "The intervention itself is unusual, but the funding method is unprecedented," and added, "This is resulting in additional liquidity being supplied to an already overheated U.S. economy and financial market."

The United States and Japan jointly intervened in the foreign exchange market starting July 31 by selling dollars and buying yen. To secure the dollars needed for this intervention, Japan utilized the Federal Reserve's Foreign and International Monetary Authorities (FIMA) repurchase agreement (repo) facility.

The FIMA repo facility allows foreign central banks to borrow dollars from the Federal Reserve by providing their holdings of U.S. Treasuries as collateral. This means that Japan could obtain the necessary dollars for yen purchases without having to sell its U.S. Treasury holdings directly on the market.

Dollar supplied through FIMA repo... Concerns over easing U.S. monetary conditions

WSJ explained that while this approach is different from the Federal Reserve directly purchasing U.S. Treasuries and therefore not exactly the same as quantitative easing (QE), it is similar in that it expands the Fed's balance sheet and injects tens of billions of dollars of liquidity into financial markets.

U.S. Treasury Secretary Scott Bessent stated that the current FIMA repo cap of 60 billion dollars should be abolished or raised. He also said, "We will take all necessary measures" to support Japan's defense of the yen.

Secretary Bessent's support for utilizing the FIMA repo facility appears to be due to concerns that a traditional sale by Japan of its U.S. Treasury holdings could drive down the price of U.S. Treasuries and raise yields.

Nathan Sheets, chief global economist at Citigroup, said, "U.S. authorities seem concerned about the potential impact on the U.S. Treasury market if Japan intervenes using traditional methods," and explained, "It suggests Secretary Bessent is trying to manage potential tail risks in the U.S. Treasury market."

However, WSJ pointed out as a problem that lending dollars to Japan in this way has the effect of easing U.S. monetary conditions. In a situation where the Federal Reserve is signaling the possibility of further interest rate hikes, expanding its balance sheet is moving in the opposite direction of tightening.

WSJ criticized, "At a time when the Fed is considered to be moving in a direction of raising rates, this is exactly the opposite of what the Fed should be doing," and added, "Balance sheet expansion also runs counter to the reduction policy repeatedly emphasized by Federal Reserve Chair Kevin Warsh."

Chair Warsh has emphasized in hearings and other venues that the Federal Reserve's balance sheet expanded excessively in past crisis responses and that quantitative tightening (QT) should be resumed.

Recognition of necessity for yen intervention... Concerns over the method

However, there was also an assessment that some degree of intervention to defend the yen was necessary. In June, the yen's real value fell to its lowest level against trading partner currencies since 1970.

Notably, even though the Bank of Japan has raised its policy interest rate five times over the past two years and the Federal Reserve has cut rates six times, the yen's weakness has persisted, leading speculative short positions on the yen to surge significantly.

WSJ noted that if speculative positions were to be unwound all at once, the global financial market could experience a sharp shock. In 2024, aggressive unwinding of yen carry trades triggered by a hawkish stance from the Bank of Japan and weak U.S. employment data caused the Japanese stock market to plummet by 12% in a single day.

Economist Sheets evaluated that intervention was reasonable to prevent a "nonlinear adjustment"—a sudden strengthening of the yen resulting in market turbulence.

WSJ said, "There is some justification for intervening now," but added, "It raises questions about whether the U.S. Treasury is concerned about hidden problems in the Treasury market and whether the Fed is being dragged toward easing at a time when it should be tightening policy."

This content was produced with the assistance of AI translation services.