Yen Weakness Triggers Tension in Interest Rate Markets

The yen's weakness has sent shockwaves through interest rate markets, according to a recent analysis by ING. The report highlights a link between pressure on the Japanese currency and US Treasuries.

The analysis suggests that the Bank of Japan's overly cautious stance and low policy rate are contributing to the yen's weakness. On updated calculations, the Japanese policy rate is about 50 basis points below neutrality, measured by the interest rate buffer relative to the Federal Reserve.

As a result, the yen has become super weak, with elevated long-dated Japanese government bond yields, including a 30-year yield hovering around 4%. The report argues that this tension could be eased through rate hikes, and sooner rather than later. While a hike might be seen as negative for the economy, it is also a choice: prioritize the yen's protection or not.

The analysis also notes that recent coordinated action by Japan and the US to strengthen the yen may have been influenced by Treasury Secretary Bessent's expectation that the Bank of Japan would tighten policy. In an unusual move, the Treasury Secretary sold euros to buy yen, which could indicate a preference to avoid selling US Treasuries.

The report advises close monitoring of these circumstances, as the yen continues to creep towards 160 against the US dollar. The prior tension has not disappeared, and timing is uncertain. A negative feedback loop into US Treasuries may develop if further intervention is entertained.