Not acting is to betray the market! The yen can only secure intervention results through interest rate hikes.

About two weeks after rare coordinated intervention by Japan and the United States briefly pulled the yen back from a 40-year low, market bets on a faster and larger interest rate hike by the Bank of Japan have surged. Whether the yen can maintain the gains from the intervention now hinges on next month's Bank of Japan policy meeting. From late July to early August, coordinated interventions by Japan, the U.S. Treasury, and South Korea pushed the yen up by about 5%, but this gain could not be sustained afterward. The yen rose from its 40-year low of 163.99 to 155.20 but has since fallen back above 159. More noteworthy than the exchange rate movements is the sharp reassessment of interest rate expectations. The market believes the U.S. is applying pressure on Japan to align its policy actions with the currency intervention, leading traders to price in an additional approximately 25 basis points of rate hikes before the end of the year. According to data from Tokyo Tanshi, the current probability of a rate hike in September stands at 76%, up from just 24% on July 30. "We need to see a more hawkish stance from the Bank of Japan; the market is trying to price that in, but at the same time, we need the central bank to validate it," said Moh Siong Sim, a currency strategist at OCBC Bank in Singapore. "If the central bank fails to take action, the yen will weaken again." This places significant pressure on the Bank of Japan: it must either deliver on the hawkish expectations that the market has priced in or watch the yen slide back toward multi-decade lows. Government stance shifts, significant pressure on the Haya-Shita government According to informed sources, Prime Minister Haya-Shita is currently supportive of a recent interest rate hike by the Bank of Japan, with a possible window in September or October. The Bank's concerns over the yen's weakness driving up prices align with the government's goal of solidifying the effects of the recent U.S.-Japan coordinated intervention. Although the Bank of Japan legally retains independence in its monetary policy and the cabinet cannot mandate specific interest rates, the government can influence central bank decisions by signaling its preferences. The Prime Minister's office stated in an email: "We believe that specific monetary policy measures, including interest rate hikes, should be determined by the Bank of Japan." The statement also noted that the central bank should work closely with the government to achieve the 2% inflation target in a "stable manner." The Bank of Japan declined to comment. U.S. Treasury Secretary Scott Benson has been a key trigger for this round of repricing. He publicly urged Japan to follow up the coordinated intervention with "policy and fundamentals," which the market widely interprets as pressure on the Haya-Shita administration to downplay its dovish stance and allow the Bank of Japan to raise interest rates. Takahide Kiuchi, an executive economist at Nomura Research Institute, stated, "As political pressures ease, the Bank of Japan is likely to accelerate interest rate hikes." It is reported that Prime Minister Haya-Shita had previously been seen as cautious about raising interest rates too quickly, fearing the potential to stifle economic recovery. Since she took office in October last year, the Bank of Japan has raised rates twice, but the benchmark rate remains at just 1%. If a hike occurs in September or October, it would mark the quickest tightening by the Bank of Japan within 12 months since the peak of the asset bubble in 1989. Coordinated Intervention and FIMA's "Rocket Launcher" Support The fundamental reason for the yen's long-term depreciation lies in the widening U.S.-Japan interest rate gap. This year, the Haya-Shita administration's large-scale stimulus and the Bank of Japan's delay in rate hikes have further accelerated the decline. The record-breaking solo intervention from April to May failed to change the situation until the U.S. Treasury joined in the coordinated buying of yen, which pulled the yen back from its 40-year low. The Japanese Ministry of Finance has committed to not hesitating to intervene again following the joint yen-buying operations with the U.S. Treasury on July 30-31. This is the first instance of such coordinated action since 1998. Unlike previous interventions, this round introduced a new financing arrangement. Japan can borrow dollars using its held U.S. Treasury securities as collateral through the Fed's FIMA repo tool, avoiding the need to directly sell U.S. Treasuries to raise intervention funds. Masahiko Loo, a senior fixed-income strategist at State Street Global Advisors, stated, "FIMA is less a financing tool and more a deterrent tool; it serves as a nearly 'rocket launcher'-like backup, forcing the market to think twice before challenging policymakers' resolve." Interest Rate Hikes as the "Only Antidote," Central Bank Faces Validation Moment But beyond intervention, the Bank of Japan has become the key variable determining whether yen stability can be sustained. Katsutoshi Inadome, a senior strategist at Sumitomo Mitsui Trust Asset Management, candidly stated, "In the short term, the only antidote for a weak yen is an interest rate hike by the Bank of Japan." Mizuho Securities has brought its baseline for the next rate hike forward to September, citing as one reason the unexpectedly hawkish tone of the Bank of Japan's summary of opinions from July. Mizuho has also raised its terminal rate forecast from 1.50% to 1.75%. Signals from within the central bank are also reinforcing this expectation. After remaining on hold during the July 31 press conference, Governor Kazuo Ueda hinted that the pace of rate hikes could accelerate due to risks of upward pressure on prices; this was the same day the U.S. and Japan coordinated their intervention in the currency market. According to informed sources, the government had conveyed support for Ueda to make hawkish remarks at the press conference prior to the July meeting. The summary of opinions from the Bank of Japan's July meeting indicated that one member suggested that given the potential CPI inflation nearing 2%, "it could be inferred that the pace of rate hikes will exceed market expectations"; another member stated that monetary policy needs greater flexibility. Central bank officials reportedly still wish to assess the economic and price developments before deciding on the timing of a rate hike but did not rule out the possibility of action in September. Although intervention and interest rate hike expectations have temporarily supported the yen, it still faces structural headwinds. A strategist at Mitsubishi UFJ Morgan Stanley Securities noted that concerns regarding Japan's fiscal deficit and unfunded tax cuts remain, which could exert upward pressure on government bond yields and weaken the durability of any interventions. This places the pressure back on the Bank of Japan. Rinto Maruyama, a senior strategist for foreign exchange and interest rates at SMBC Nikko Securities, warned that bond yields and swap rates have already priced in the September action; if the central bank delays again, it would be interpreted by the market as "a betrayal of market trust." Maruyama added, "Market participants will lose confidence in the Bank of Japan's ability to continue raising rates. In that case, the yen will decline, and long bond yields will rise further due to intensified inflation concerns."