Fed may be pulled into Bessent’s effort to support Japan’s yen: Analysis

The Federal Reserve may soon be drawn into the Trump administration’s efforts to back the embattled currency of U.S. ally Japan.

Treasury Secretary Scott Bessent wants the apolitical Fed to expand a lending facility that would enable Japan to support its currency without roiling the sensitive U.S. Treasurys market. That request comes as new Fed Chairman Kevin Warsh is seeking to rewrite the relationship between the Treasury and the Fed. How the two collaborate could have important consequences for the management of the $29 trillion Treasurys market and could see the Fed take on a new role backing U.S. financial diplomacy.

It isn’t clear how much support the chairman has within the Fed for major policy changes. The Fed declined to comment.

The Treasury didn’t respond to a request for comment about its plans.

Bessent said in a post on X on Sunday that the U.S. had intervened in foreign exchange markets to support the Japanese yen. It is routine for Japan to intervene on behalf of its perennially weak currency. But it is exceedingly rare for the U.S. to join in. The U.S. joined a broader effort in 2011 to support Japan after a devastating earthquake and tsunami.

The yen has slid sharply since 2022, when sharply higher interest rates in the U.S. weren’t matched in Japan. Economists have debated the factors behind the slide, but they include huge debt issued by the Japanese government, a shrinking and aging population that weighs on growth prospects and, lately, expensive energy imports. A weak currency can stoke inflation by making imports more expensive, and Japan’s government has frequently expressed concern about the issue. 

At one point last week, one U.S. dollar bought nearly 164 Japanese yen, the weakest the currency pair has been since 1986, according to Factset data.

Then the U.S. joined Japanese authorities to try to backstop the yen. “Friday’s coordinated foreign exchange actions countered disorderly yen movements,” Bessent said Sunday. The Treasury sold euros from its Exchange Stabilization Fund to fund yen purchases, the Financial Times reported. The yen retreated 3.5% from its low to just under 157 by Monday afternoon U.S. time.

That action may have also been aimed at the Treasury market. The difference in interest rates between Japan and the U.S. has contributed to a long-standing “carry trade,” where investors borrow cheaply in yen and invest in higher-returning Treasurys or in the AI-driven U.S. stock boom.

But the future of that trade is in doubt. President Donald Trump’s tariffs and other policies have prompted global investors to hedge their dollar trades.

“The yen carry trade has broken down,” Torsten Slok, chief economist at Apollo Global Management, wrote in a research note published on Sunday.

Arresting the slide in the yen could bolster the carry trade and help keep up demand for Treasurys in the U.S. When financial firms, governments, or central banks sell Treasurys, their prices fall and yields rise.

The 10-year note rose…