The Mysterious Intervention

It’s perplexing that the U.S. Treasury Secretary, Scott Bessent, who worked for the hedge fund that broke the pound and led a major short position in yen in 2013 when he was CIO of Soros Fund Management, would work with Japan to defend the yen.

Soros believed that currency interventions without fiscal consolidation never really worked. The definitive case study was the UK crisis in 1992 where the government spent £27 billion defending the peg within the European Exchange Rate Mechanism while running a large fiscal deficit. George Soros calculated that the UK would not tighten its fiscal position, making the peg untenable. The 1994 Mexican Tequila Crisis produced a 50% collapse in the peso despite Mexico burning through its dollar reserves. The Asia Crisis in 1997, the Russian default in 1998, and multiple episodes in Argentina all failed. The cases where a currency defence worked were accompanied by fiscal and monetary commitments such as the Plaza Accord in 1985.

Last Thursday, Japan spent $53 billion in the largest single-day intervention of the yen. On Friday, the U.S. Treasury, acting through the New York Fed, sold euros to buy yen, the first U.S.-supported intervention since 1998. On Fox Business, Bessent said the yen “seems very undervalued to me”. A Reuters reporter took a snapshot of his Camp David notebook, which had Buy Japanese Yen $5bn-$10bn as a to-do item.

The yen was trading around 164 in the prelude before the intervention, despite several prior interventions. Prime Minister Takaichi showed no signs of backing down on her fiscal spending despite her approval rating falling 10 points partly due to disappointment about Japan’s persistent inflation (she still polls 53%-58% approval). Takaichi is now trying to push for a food tax cut worth about Y5tn per year. The bond market is worried.

Japan’s motivation to arrest the yen’s decline is clear: try to ease inflation. Bessent’s motivation to help is a bit less clear to me. One theory is that Bessent seems concerned about JGB volatility. This volatility could transmit to U.S. government bonds. A weak yen also hands Japan a competitive advantage in manufacturing, the kind of thing that draws Trump’s attention. But probably the most significant fear is that Japan’s only tool to intervene in its currency is to sell U.S. government bonds, and as the top foreign bondholder, perhaps Bessent is concerned this may lead to issues in the Treasury market.

Another datapoint is the Treasury is considering plans to actively lend in the repo market. This allows the Fed to run with a smaller balance sheet and could help smooth time periods where there is a mismatch between supply and demand. This could be a bridge for the Treasury and Fed to manage significant Treasury bond selling by Japan.

My best guess is that this has less to do with sentiment toward Tokyo and more to do with protecting the plumbing of the Treasury market itself. If JGB volatility keeps forcing Japan to liquidate dollar reserves to fund its own defence, the marginal buyer of U.S. debt thins out precisely when Washington's deficit needs it the most.

End Note

I’m in Korea, staying close to Busan, Korea’s second largest city. Korea has had the hottest temperatures in its 122-year modern weather history. Yangsan recorded temperatures of 42.5 degrees Celsius (109 degrees Fahrenheit). Temperatures around Busan topped 40 degrees Celsius. The Korean Meteorological Administration (KMA) issued its first-ever Severe Heatwave Warning to handle life-threatening regional temperatures.

Interestingly, the number of heat illnesses and fatalities are slightly lower this year (1,781 people admitted to emergency rooms due to the heat and 13 fatalities versus 2,779 emergency room visits and 16 deaths last year). The combination of air conditioning and the emergency warnings have led to mitigation strategies that have reduced fatalities.

In contrast, England, with a similar population size, had 2,877 heat-associated deaths this summer. Emergency room visits are unknown due to England’s lack of a classification system, but many medical centres had to declare “Critical Incidents” due to unsafe overcrowding in emergency rooms. Anecdotally, there was an influx of patients suffering from heat exhaustion and dehydration.

The main difference is air conditioning. Over 90% of Korean homes have air con whereas less than 5% of English homes have it.

At a wet bulb temperature of 35 degrees Celsius the air is too hot and humid for sweat to evaporate. This is about 40-42.5 degrees Celsius in normal humidity conditions. This year we started to see these types of temperatures, and in the years ahead the UK (and Europe where many homes also lack air conditioning) are likely to see a major incident unless more people install air conditioning.

If AI takes your job in the UK, air conditioning installation will have a very high demand curve for years to come.

Omar Sayed