why the U.S.-Japan intervention not working

The Japanese yen has erased about half the gains from a historic U.S.-Japan intervention less than two weeks ago, as the fundamental forces that have pressured the currency to multi-decade lows prove increasingly resilient against short-term measures. 

Japan’s currency is currently trading at over 159 per dollar, after having strengthened to 155 in the days following the intervention after it crossed 163.

“Intervention has scared markets, but has not stopped the laws of finance which say money flows in the direction of maximum returns … as long as the cost of money in Japan is lower than the return overseas, carry trades will re-assert,” said Jesper Koll, expert director at Monex Group.

At the heart of the problem is the gap in returns between Japan and the U.S. With Japanese borrowing costs still far below those in the U.S. and other markets, prompting investors to borrow cheaply in yen and invest in higher-yielding assets, also known as the classic carry trade. 

The backdrop has become even tougher as higher Treasury yields and elevated oil prices, which pose a particular problem for energy-importing Japan, restore some of the macro forces favoring the dollar. 

He argues that intervention has succeeded in reducing speculative excess and raising the risks for traders betting against the yen, even if it has not eliminated the underlying yield advantage supporting the dollar. 

“The intervention successfully reset market psychology and demonstrated an unusually strong degree of U.S.-Japan policy coordination. What it has not yet done is eliminate the yield advantage supporting the dollar,” said Masahiko Loo, senior fixed income and currency strategist at State Street Global Advisors. 

The yield gap remains wide: benchmark 10-year U.S. Treasury yield is at 4.686%, compared with 2.846% for 10-year Japanese government bonds, leaving investors with a substantial incentive for holding U.S. debt.

“It’s better understood as a success in slowing speculation but not yet a success in changing fundamentals,” Loo said. 

That leaves attention squarely on the Bank of Japan, whose next monetary policy meeting is scheduled for September.

Monex’s Koll said the bigger shock for investors was not intervention itself but the BOJ’s reluctance to tighten policy more aggressively, which raises questions over whether concerns about the banking system or Japan’s enormous public debt burden are constraining policymakers.

In the absence of higher Japanese rates or falling U.S. yields, investors still have an incentive to send money overseas.

John Wood, chief investment officer for Asia at Lombard Odier, said the latest intervention would…