Key Highlights

  • The United States and Japan carried out a coordinated intervention to support the yen after it fell to roughly 163 per dollar, its weakest level in about four decades.
  • Following the intervention, the dollar dropped to around 157 yen, with Japan's finance ministry confirming it purchased yen in coordination with the US Treasury.
  • The Bank of Japan's holdings of Japanese government bonds have declined from a peak of 53.9% of all outstanding bonds in 2023 to around 49% currently, as the central bank gradually shrinks its balance sheet.
  • Japan's debt-servicing costs have risen to 25 trillion yen in the current fiscal year, with government projections showing costs could reach roughly a third of total spending within three years.

Yen Falls to Four-Decade Low Before Coordinated Support

The Japanese yen weakened to roughly 163 per dollar, its lowest level in about four decades, before the United States and Japan carried out a coordinated intervention to support the currency. Following the action, the dollar fell to around 157 yen. Japan's finance ministry confirmed it had purchased yen in coordination with the US Treasury, describing the move as aimed at countering excessive volatility and disorderly movements in currency markets. The ministry said it would utilize the Federal Reserve's foreign and international monetary authorities repo facility for future interventions, a mechanism that allows foreign central banks to obtain short-term dollar liquidity without selling their Treasury holdings outright.

The intervention reflected mounting concern in Tokyo that a persistently weak yen was pushing up import prices and inflation, given Japan's heavy reliance on imported energy and goods. It also marked one of the first coordinated yen-buying operations between the two countries in years, following a joint statement issued between the finance ministries last year. The US Treasury said it would not hesitate to participate in further joint intervention if disorderly currency moves continued.

Japan's Debt Burden Complicates Policy Options

Following the 1997 Asian financial crisis, Japan adopted a zero-interest-rate policy that caused the Bank of Japan's holdings of Japanese government bonds to rise from 11.6% of all outstanding bonds in 2013 to a peak of 53.9% in 2023. The central bank has since begun shrinking its balance sheet, with holdings now at around 49% of outstanding bonds, and has raised its policy rate from zero to 1%. The Bank of Japan has described this process as a gradual normalization of monetary policy, aiming to avoid triggering a disorderly rise in bond yields even as it reduces its footprint in the market.

Debt-servicing costs have risen to roughly 25 trillion yen in the current fiscal year, about a quarter of total government spending, with projections suggesting costs could reach roughly a third of spending within three years. Japan's total debt-to-GDP ratio exceeds 200%, the highest among major economies, though net debt is estimated closer to 130% once government-held financial assets are accounted for. Long-term Japanese government bond yields have climbed considerably from near-zero levels seen as recently as 2021, with 30-year yields reaching around 4% and 10-year yields around 2.7%.

On paper, raising interest rates further would be the clearest route to strengthening the yen, since inflation has been rising even as the broader economy remains comparatively weak. However, doing so would also increase the government's debt-servicing burden, creating a difficult trade-off for policymakers who must balance currency stability against fiscal sustainability.

Global Implications of a Potential Debt Strain

Just 7% of Japanese government bonds are held by foreign investors, which may help limit the risk of a disorderly market reaction compared with countries more dependent on foreign bondholders. Still, yen-funded investment strategies, commonly known as the carry trade, have supported markets globally in recent years, as investors borrow cheaply in yen to invest in higher-yielding assets elsewhere. Foreign hedge funds have also increased their presence in Japan's government bond market in recent years, often using leverage through repurchase agreements and interest rate derivatives, a dynamic the Bank of Japan has flagged as a potential channel through which global market stress could spread into Japan's bond market.

A disorderly rise in Japanese yields, or a rapid unwind of yen carry trade positions, could have ripple effects well beyond Japan's borders given the scale of capital tied to the trade. The coordinated intervention suggests both Tokyo and Washington are motivated to avoid such an outcome, though the underlying tension between supporting the yen and managing Japan's debt burden remains unresolved.