Japan's yen has stopped falling; that is a risk to global markets

For much of the decade the Japanese yen did a marvellous impersonation of a falling knife. It slid through one psychically important level after another, touching ¥164 in late July, its weakest in forty years. Then, in the first days of September, it snapped the other way. The currency rose almost 4.5% in a week to ¥152.89, its strongest since spring, as the biggest build-up of cheap-yen borrowing in three decades began to come undone. Japan's finance minister, Satsuki Katayama, greeted the reversal in her customary way. "Our stance has not changed," she insisted.

The statement is true in the narrow sense: the finance ministry still stands ready to buy the yen in a disorderly market. Yet its meaning has quietly inverted. After months of watching its interventions fail, Japan now finds itself defending a currency that will not stop rising, with consequences that reach well beyond Tokyo. The cost of the cheapest money on Earth is re-pricing, and global markets are the venue where it is being paid.

Start with how the defence failed, because the scale explains what has changed. The yen's weakness was never really a currency problem; it was an interest-rate and capital-flow problem. Japan's policy rate was stuck near zero for years while the Federal Reserve pushed its own far higher, handing investors a dependable two-to-three-point yield gap for borrowing yen and buying dollars instead. Japan imports nearly all its energy, and a spike in oil prices attached a fat import bill to the slide. And the politics pointed one way: Sanae Takaichi, the prime minister, had built her government on reflation — cheap borrowing, relaxed fiscal policy and a weak currency that flattered exporters. For all that, intervention and rate rises bought almost nothing. Tokyo spent ¥11.7tn ($72.8bn) leaning on the yen in April and May, then a record ¥15.4tn ($96.5bn) between July 30 and August 26. The yen kept sliding anyway. The joint action was historic mainly in its staging: for the first time since 2011 the United States joined in, with Treasury Secretary Scott Bessent branding the yen "very undervalued" and Washington opening its dollar facilities to fund Tokyo's buying.

What finally turned the market was not a bigger cheque but a changed expectation. Investors stopped fighting the Bank of Japan, whose next hike they now put at roughly a 97% chance on September 18, and started betting against the yen's most loyal friend, the carry trade. That trade is just a leveraged wager that yen borrowed cheaply can be invested anywhere paying more. For years it was the closest thing finance offered to a free meal, and Japan sat at the head of a buffet that served the world. Cross-border yen borrowing reached an estimated ¥360tn, or $2.35tn — the largest such position in three decades.

When the funding currency stops falling, that trade runs in reverse. Borrowers must buy the yen back to repay what they owe, and in doing so they bid the yen higher, which forces more of them to cover, and so on. Reversals of this kind are reflexive and can be violent. The one now under way began with a cascade of stop-losses below ¥155 and broadened into a general strengthening against the peso and the lira — the very currencies carry traders favoured.

Here is where the story leaves the yen's own chart and reaches a portfolio. A yen that rises briskly is a global deleveraging event, because the yen sits at the funding end of trades that finance holdings of higher-yielding assets everywhere, including American equities and Treasuries. The precedent is unpleasant. In the summer of 2024 a sharp yen rally accompanied a worldwide sell-off in technology and risk assets. Japan's own investors hold roughly $1.1tn of American debt; a strong yen and rising Japanese yields give them reason to bring capital home, pushing up borrowing costs for everyone else. Bessent's warning that traders should not bet against the yen, after Washington helped push it up, underlines how thoroughly intervention risk now cuts both ways.

The reversal hands Takaichi a different set of pains. A stronger yen relieves households squeezed by import inflation — a political gift. But it raises the cost of funding her ambitions, from a ¥370tn public-investment plan to a promised cut in the consumption tax on food; and it squeezes the exporters whose profits her model relied on. The cheap-yen constituency and the households she was elected to help are pulling in opposite directions.

The honest uncertainty is whether the surge holds. Morgan Stanley, which put the yen's current fair value at roughly ¥165–167, notes that a currency at these levels is no longer the screaming bargain of the spring; the opening gap has been largely closed. That is why the risk of disappointment is sharp. Citigroup's trading desks warn the market's expectations have "run too high" and that the Bank of Japan, scarred by the disorder of 2024, may not want to test them. If the central bank underdelivers, or if American inflation data this week pushes the Fed toward another hike, the funding side of the trade will not have genuinely repriced and the yen could slide as quickly as it rose. A genuine, persistent unwind — State Street's bulls see the dollar falling toward the mid-140s — is the condition for much more. The finance minister's stance — buy on the way down, tolerate the squeeze on the way up — is the constant. The thing that sets the yen's level, a central bank's reaction function and the Fed's appetite for tightening, has never been within her control. "Our stance has not changed" was a promise about loyalty to a currency. It says nothing about who sets its price.