Institution: Japan's use of Federal Reserve tools may test the determination of the U.S. and Japan to boost the yen.

Evercore ISI indicated that a rarely used Federal Reserve liquidity tool might help Japan avoid supporting the yen by selling U.S. Treasury bonds. However, a long-term reliance on this tool could instead tempt the market to test the resolve of both the U.S. and Japan to boost the yen. The foreign and international monetary authorities' repurchase mechanism allows overseas institutions to obtain U.S. dollars using their holdings of U.S. Treasury bonds as collateral, without needing to sell bonds on the open market to raise cash. This tool was established during the pandemic in 2020 to provide liquidity to counterparties while avoiding excessive disruption to the U.S. Treasury market, and it was converted into a permanent mechanism in July 2021. However, the tool has limitations, with a daily usage cap of $60 billion for each counterparty. Evercore ISI strategists Marco Casiraghi and Gang Lyu stated that this cap is only slightly higher than the estimated amount that Japan used for currency market intervention last Thursday. In a report to clients on Monday, the two strategists wrote that this limits the role of the tool in sustained interventions and raises questions about whether the U.S. is willing to support repeated and large-scale foreign exchange interventions. "We believe that focusing on this Federal Reserve repurchase tool with a cap may backfire, tempting the market to test the determination of the U.S. and Japan to boost the yen when large-scale sales of U.S. Treasury bonds are needed," they stated.