Japanese yen banknotes placed on top of a Japanese flag. [Reuters]
Japanese yen banknotes placed on top of a Japanese flag. [Reuters]

The United States' joint currency intervention with Japan to prop up the yen is inadvertently flooding markets with dollar liquidity — an unintended side effect at a time when monetary tightening is needed to curb inflation, analysts said. The operation is effectively expanding the Federal Reserve's balance sheet, the opposite of what policymakers have been calling for.

The Wall Street Journal reported Thursday that the Trump administration's use of the Fed's Foreign and International Monetary Authorities (FIMA) repo facility to conduct joint yen-defense intervention with Japan is generating unexpected consequences in financial markets.

"The intervention has an effect similar to quantitative easing, expanding the Fed's balance sheet and injecting tens of billions of dollars of liquidity into the economy," the Journal said. "The funding mechanism is unprecedented, and it amounts to pumping additional liquidity into an already overheated US economy."

The United States and Japan began joint currency market intervention on Friday, July 31, selling dollars and buying yen to support the Japanese currency.

Japanese Finance Minister Katayama Satsuki officially confirmed Monday that Japan had used the Fed's FIMA repo facility during the intervention. US Treasury Secretary Scott Bessent then signaled the possibility of expanding the program, saying it would be reasonable to raise or eliminate the current $60 billion cap on the FIMA repo facility.

The Fed created the FIMA repo facility during the COVID-19 pandemic in 2020 to address a global dollar shortage. Under the arrangement, foreign central banks pledge their US government bond holdings as collateral with the Fed in exchange for dollar loans.

Markets widely view the move as a deliberate choice to prevent Japan from selling its US government bond holdings outright.

Had Japan directly sold its US Treasuries to fund yen-defense operations, interest rates on those bonds could have spiked sharply. By accepting US government bonds as collateral and supplying dollars in return, the Fed avoided that outcome.

The Journal said this approach conflicts with the Fed's current monetary policy stance.

"At a time when the Fed is moving toward raising its benchmark interest rate, this is the exact opposite of what the Fed should be doing," the paper said, adding that the balance sheet expansion also runs counter to the quantitative tightening policy that Fed Chair Kevin Warsh has consistently emphasized.

Warsh reiterated the need for quantitative tightening at a recent congressional hearing, saying the Fed's balance sheet — which ballooned during the pandemic — must be brought back down.

The Journal said Japan's yen defense itself carries some justification. A sharp yen rebound could trigger a mass unwinding of yen carry trades — in which investors borrow cheaply in yen to fund investment in overseas assets — sending shockwaves through global financial markets.

"The problem is not the intervention itself, but the method," the paper said, adding that the approach is fueling market suspicion that the US Treasury may be worried about hidden vulnerabilities in the US government bond market, and that the Fed risks being pulled back toward easing at a time when it should be tightening.


sjy@heraldcorp.com