Brad Setser on the US's Unusual Japanese Yen Intervention

The core argument. Brad Setser's view is that the yen's collapse to roughly 155-162 to the dollar is an extreme overshoot relative to fundamentals, and that the joint US-Japan intervention — while unusual in form — has a reasonable chance of holding if the Bank of Japan continues raising rates. He also pushes back on the popular 'fiscal dominance' bear case for Japan, arguing Japan's underlying fiscal trajectory now looks better than the US's.

The mechanism — why the yen got this weak. Setser frames 2026 as a broader story of East Asian currency weakness despite record current account surpluses across the region: Korea's surplus is heading from ~$100bn toward $300-400bn, Taiwan's is set to roughly double toward 25-30% of GDP. In Korea's case, paradoxically, good news for Samsung/Hynix triggers foreign-investor selling due to concentration limits, plus pension outflows and retail demand for levered single-stock ETFs — pushing the won weaker even as fundamentals improve. Taiwan's central bank has deliberately weakened the currency by relaxing hedging rules for life insurers and leaning on TSMC's conversion timing. Japan is different again: it runs a 5%-of-GDP current account surplus (driven by investment income, not trade), holds ~$1.2 trillion in reserves plus $900bn+ in GPIF foreign assets — a government foreign-asset position near 50% of GDP — yet the yen has been the weakest of the group, chiefly because the BOJ has been slow to raise its policy rate (still 1%) despite inflation running above target. Setser notes the BOJ's caution reflects a desire to see the yield curve steepen first and concern about funding costs on bank and government balance sheets, more than the market's preferred 'fiscal fear' narrative, which he says is overstated.

He estimates a modest, not enormous, speculative short-yen carry trade was in play, layered on top of hedging dynamics among real-money investors: Nikkei gains prompt more foreign hedging, GPIF doesn't hedge against Nasdaq gains, and Japanese life insurers have been running lower hedge ratios — all adding depreciation pressure distinct from classic speculation.

The intervention mechanics. Treasury Secretary Scott Besant's leaked to-do list ('buy JPY, $5-10bn') preceded a joint intervention in which the US sold euros against yen — a structure Setser attributes partly to Besant wanting to signal 'this is a yen view, not a dollar view' while still using available reserves (the ESF holds roughly $20bn in FX, $20bn in liquid dollar cash, and $160-170bn in SDRs — not unlimited firepower). The bulk of the actual intervention was Japan's Ministry of Finance buying yen against dollars. Japan also tapped the Fed's FEMA repo facility, letting it post Treasuries as collateral for dollars rather than selling bonds outright into the market — useful, Setser says, for holding legacy high-coupon bonds without crystallizing losses, though the facility carries an above-market rate and (at time of taping) a roughly $60bn cap.

Setser's read on Besant's motive: concern that unmanaged East Asian currency weakness could eventually force reserve sales that spill into Treasury market pressure, plus a stated aim (echoed by the President) of 'helping a friend.' He distinguishes this from the classical Treasury concern — that weak Asian currencies disadvantage US manufacturers (Detroit) — which Besant has not emphasized.

What has to be true. Setser's base case that the intervention works hinges on the BOJ actually raising rates, 'maybe raise rates several times' — and he flags that if the BOJ fails to hike in September, the yen's defense 'will be tested clearly,' signaling a lack of full domestic commitment. He notes MOF has effectively drawn a line of concern around ¥160, a psychological level it deterred shorts at previously but failed to defend last time. Supporting factors he cites: long-term US-Japan rate differentials have already converged (yen 'should be stronger' on that basis alone), oil prices are off highs, and Japan's current account surplus remains intact. A structural point unique to Japan, in his view: government and pension-fund holders of the bulk of unhedged foreign assets historically don't repatriate gains, so JGB/yen flows haven't equilibrated the way theory would predict — but this is not a fully baked forecast, more a factor he weighs 'a little more favorably' than the conventional international-macro view.

On the fiscal-doom case. Addressing host framing about fiscal dominance and JGB yields rising from near-zero to ~4% at the 30-year, Setser argues Japan's primary balance (ex-interest) is now roughly flat, trending toward surplus — better than the US, UK, France, and (he says) Germany once defense spending is counted. He contrasts this with the US primary deficit near 6% of GDP and rising. He adds a wrinkle: Japan's government earns more on its dollar reserves and GPIF foreign holdings than it pays on yen liabilities, so net interest costs have at times been close to zero — a dynamic that could deteriorate only if nominal rates rise sharply without accompanying inflation/growth, which he doesn't view as the current trajectory. He notes political friction, with PM Takaichi pushing back against MOF's push for larger primary surpluses, which has generated market unease even though the underlying fiscal trend remains comparatively strong.

Setser closes with a mechanical point: Japan is selling dollars it originally bought in the $80-100 range at closer to $160 now, meaning the intervention itself modestly reduces Japan's gross debt in yen terms.