Japan Unleashes Historic Yen Intervention, Dollar-Yen Pain Trade Flips

Japan's recent intervention in the foreign exchange market has sparked a historic shift in how policymakers combat yen weakness, according to Masahiko Loo, Senior Fixed Income Strategist at State Street Investment Management. Speaking on Bloomberg, Loo explained that last week's US-Japan currency intervention marked a deliberate move away from selling U.S. Treasuries to prop up the Japanese yen.

The fear is that Japan will sell U.S. Treasuries to right-size its currency, creating funding problems in the U.S. market. With intervention sizes typically ranging between $35-$50 billion, forced Treasury sales at this scale can jolt a market already digesting elevated yields. The 10-year Treasury yield closed at 4.68% on July 30, sitting near the 12-month high of 4.71% hit on July 23.

However, Loo credits both the U.S. and Japan for using the Foreign and International Monetary Authorities (FEMA) repo facility to lend dollars to foreign central banks in exchange for pledged Treasuries. This allows intervention without physically selling U.S. Treasuries, signaling a smart move from both countries.

Loo believes that the dollar-yen pain trade has flipped direction, with the top seen near 164. The next key watch level is 155, which suggests a strengthening yen rather than a weakening one. Volatility indicators show a similar shift in tone, with the VIX retreating and the 10-year-minus-2-year Treasury spread steepening.