Morgan Stanley: Why does the future direction of the yen depend on the Federal Reserve?
2026-08-19 19:24:57
The yen's fall to a more than 30-year low will have a ripple effect on U.S. Treasury yields, borrowing costs, and global market volatility. 
The yen fell to a 30-year low, prompting a rare joint intervention by the US and Japan, but the move had limited effect on supporting the yen. With the Bank of Japan's policy rate at only 1%, this intervention may signal that the Bank of Japan may raise interest rates sooner rather than later. The yen's long-term outlook depends more on US monetary policy than on exchange rate intervention or the Bank of Japan's actions; thus, the yen has become a barometer of global interest rates and liquidity. The yen's sustained weakness over the years has been primarily driven by Japan's near-zero interest rates, making it the world's lowest-cost funding currency. At the end of July, the US and Japan implemented historic intervention measures to boost the yen; however, the yen depreciated again. On July 29, the dollar was around 163 yen; after the intervention on July 31, the yen strengthened by about 5%, reaching 155 yen to the dollar. By August 18, the yen had depreciated again by 2.5%, falling back to around 159 yen to the dollar. The yen remains in historically low territory in the era of floating exchange rates: the last time the USD/JPY pair approached 160 was in April 2024, and that level was last seen in 1990. Currently, the yen is depreciating by about 40% from its long-term average since the mid-1980s. Measured on an inflation-adjusted, trade-weighted basis, the yen's depreciation is even greater. David Adams, head of G10 FX strategy at Morgan Stanley Research, stated, "While intervention has temporarily altered the market narrative, the core fundamentals determining the yen's trajectory have not changed. A stronger yen requires either lower US interest rates, a faster tightening of monetary policy by the Bank of Japan, or both." The impact of yen fundamentals extends far beyond Japan. Markets heavily utilize low-cost yen financing across various global asset classes; Japanese investors are also among the largest holders of US Treasury bonds. Therefore, even if a portfolio completely excludes yen assets, the yen's movements will still impact bond yields and borrowing costs, leading to portfolio volatility. An Unusual Currency Intervention Adams points out that on August 3, US and Japanese officials confirmed a joint currency intervention and stated they would intervene again if necessary. It is rare for policymakers to implement intervention and send signals in this manner. The Japanese Ministry of Finance sold approximately $85 billion worth of yen on July 30 and 31, catching investors off guard. The initial intervention occurred the day before the Bank of Japan's policy meeting. Meanwhile, the US sold euros to buy yen, without disclosing the transaction size. Adams stated, "The US authorities chose not to use the dollar to avoid questions about a shift in US foreign exchange policy." Squeezing Yen Speculative Positions There are multiple motivations behind the authorities' intervention to boost the yen, one of which is curbing further yen selling in the market. For many years, investors have borrowed low-cost yen and invested in other high-yield assets to earn returns. This is the yen carry trade. Once the yen strengthens, the attractiveness of this strategy decreases. Carry trades are a crucial source of liquidity in global markets. A large-scale unwinding of these trades would force leveraged investors to reduce their risk exposure, amplifying volatility in the stock, bond, and foreign exchange markets. Koichi Sugisaki, head of macro strategy for Japan at Morgan Stanley, stated, "We believe the trigger and primary purpose of this intervention is to squeeze speculative positions and prevent rapid, one-sided, and disorderly market movements." The US intervention may be related to the impact of rising Japanese interest rates on the US Treasury market. Japan is one of the largest holders of US Treasury bonds. If Japanese interest rates rise, Japanese investors may sell US assets and repatriate funds, pushing up US Treasury yields and increasing borrowing costs for the overall US economy, leading to higher interest rates on mortgages, auto loans, and corporate debt. Koichi Sugisaki stated, "The market generally believes that the Bank of Japan's policy actions are lagging, and fluctuations in the Japanese interest rate market will spill over and disturb the US Treasury market. Stabilizing Japanese interest rates through foreign exchange channels could potentially mitigate this spillover impact. The intervention may be aimed at buying time and allowing the market to digest expectations of the Bank of Japan's monetary policy normalization in advance." Sugisaki added that the intervention also aims to convey a firm stance of defending the yen's exchange rate. Will the Bank of Japan raise interest rates sooner? Morgan Stanley research economists predict that the Bank of Japan will raise its current policy rate of 1% to 1.25% in October and to 1.5% in March of the following year. However, this foreign exchange intervention suggests that the Bank of Japan may begin raising interest rates at its next policy meeting in September. Adams stated, "Policymakers may be willing to accelerate the pace of rate hikes, especially if it alleviates U.S. concerns—a weaker yen, rising long-term yields, and spillover effects on overseas markets. However, the likelihood of a rate hike in October is higher than in September, when policymakers will have more comprehensive data and financial market information to support a rate hike." The Federal Reserve is the core variable for the yen's outlook . Morgan Stanley Research estimates the current fair exchange rate of the yen at 165-167 yen to the dollar. However, with the Federal Reserve maintaining its current interest rates and potentially initiating rate cuts next year, the long-term fair exchange rate of the yen is expected to strengthen to 155 yen to the dollar, corresponding to an appreciation of approximately 7%. This prospect also reflects the limitations of exchange rate intervention: the long-term yen trend is primarily driven by U.S. interest rates, not Japanese interest rates, and the market generally believes that the Bank of Japan's policy adjustments have lagged behind the situation. Koichi Sugisaki noted, "Unless the Bank of Japan quickly raises interest rates to above 1.75%-2% in the short term, this market sentiment will be difficult to reverse." Therefore, for investors, each round of US inflation data, employment reports, and statements from the Federal Reserve become signals for judging the yen's trajectory, while also indicating changes in government bond demand and global liquidity. Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research, stated, "The key question remains whether the forces driving the yen's depreciation have begun to reverse. We believe the conditions for a reversal are brewing, but have not yet arrived. For the yen, its outlook depends more on the Federal Reserve than on currency intervention or the Bank of Japan itself."
The yen fell to a 30-year low, prompting a rare joint intervention by the US and Japan, but the move had limited effect on supporting the yen. With the Bank of Japan's policy rate at only 1%, this intervention may signal that the Bank of Japan may raise interest rates sooner rather than later. The yen's long-term outlook depends more on US monetary policy than on exchange rate intervention or the Bank of Japan's actions; thus, the yen has become a barometer of global interest rates and liquidity. The yen's sustained weakness over the years has been primarily driven by Japan's near-zero interest rates, making it the world's lowest-cost funding currency. At the end of July, the US and Japan implemented historic intervention measures to boost the yen; however, the yen depreciated again. On July 29, the dollar was around 163 yen; after the intervention on July 31, the yen strengthened by about 5%, reaching 155 yen to the dollar. By August 18, the yen had depreciated again by 2.5%, falling back to around 159 yen to the dollar. The yen remains in historically low territory in the era of floating exchange rates: the last time the USD/JPY pair approached 160 was in April 2024, and that level was last seen in 1990. Currently, the yen is depreciating by about 40% from its long-term average since the mid-1980s. Measured on an inflation-adjusted, trade-weighted basis, the yen's depreciation is even greater. David Adams, head of G10 FX strategy at Morgan Stanley Research, stated, "While intervention has temporarily altered the market narrative, the core fundamentals determining the yen's trajectory have not changed. A stronger yen requires either lower US interest rates, a faster tightening of monetary policy by the Bank of Japan, or both." The impact of yen fundamentals extends far beyond Japan. Markets heavily utilize low-cost yen financing across various global asset classes; Japanese investors are also among the largest holders of US Treasury bonds. Therefore, even if a portfolio completely excludes yen assets, the yen's movements will still impact bond yields and borrowing costs, leading to portfolio volatility. An Unusual Currency Intervention Adams points out that on August 3, US and Japanese officials confirmed a joint currency intervention and stated they would intervene again if necessary. It is rare for policymakers to implement intervention and send signals in this manner. The Japanese Ministry of Finance sold approximately $85 billion worth of yen on July 30 and 31, catching investors off guard. The initial intervention occurred the day before the Bank of Japan's policy meeting. Meanwhile, the US sold euros to buy yen, without disclosing the transaction size. Adams stated, "The US authorities chose not to use the dollar to avoid questions about a shift in US foreign exchange policy." Squeezing Yen Speculative Positions There are multiple motivations behind the authorities' intervention to boost the yen, one of which is curbing further yen selling in the market. For many years, investors have borrowed low-cost yen and invested in other high-yield assets to earn returns. This is the yen carry trade. Once the yen strengthens, the attractiveness of this strategy decreases. Carry trades are a crucial source of liquidity in global markets. A large-scale unwinding of these trades would force leveraged investors to reduce their risk exposure, amplifying volatility in the stock, bond, and foreign exchange markets. Koichi Sugisaki, head of macro strategy for Japan at Morgan Stanley, stated, "We believe the trigger and primary purpose of this intervention is to squeeze speculative positions and prevent rapid, one-sided, and disorderly market movements." The US intervention may be related to the impact of rising Japanese interest rates on the US Treasury market. Japan is one of the largest holders of US Treasury bonds. If Japanese interest rates rise, Japanese investors may sell US assets and repatriate funds, pushing up US Treasury yields and increasing borrowing costs for the overall US economy, leading to higher interest rates on mortgages, auto loans, and corporate debt. Koichi Sugisaki stated, "The market generally believes that the Bank of Japan's policy actions are lagging, and fluctuations in the Japanese interest rate market will spill over and disturb the US Treasury market. Stabilizing Japanese interest rates through foreign exchange channels could potentially mitigate this spillover impact. The intervention may be aimed at buying time and allowing the market to digest expectations of the Bank of Japan's monetary policy normalization in advance." Sugisaki added that the intervention also aims to convey a firm stance of defending the yen's exchange rate. Will the Bank of Japan raise interest rates sooner? Morgan Stanley research economists predict that the Bank of Japan will raise its current policy rate of 1% to 1.25% in October and to 1.5% in March of the following year. However, this foreign exchange intervention suggests that the Bank of Japan may begin raising interest rates at its next policy meeting in September. Adams stated, "Policymakers may be willing to accelerate the pace of rate hikes, especially if it alleviates U.S. concerns—a weaker yen, rising long-term yields, and spillover effects on overseas markets. However, the likelihood of a rate hike in October is higher than in September, when policymakers will have more comprehensive data and financial market information to support a rate hike." The Federal Reserve is the core variable for the yen's outlook . Morgan Stanley Research estimates the current fair exchange rate of the yen at 165-167 yen to the dollar. However, with the Federal Reserve maintaining its current interest rates and potentially initiating rate cuts next year, the long-term fair exchange rate of the yen is expected to strengthen to 155 yen to the dollar, corresponding to an appreciation of approximately 7%. This prospect also reflects the limitations of exchange rate intervention: the long-term yen trend is primarily driven by U.S. interest rates, not Japanese interest rates, and the market generally believes that the Bank of Japan's policy adjustments have lagged behind the situation. Koichi Sugisaki noted, "Unless the Bank of Japan quickly raises interest rates to above 1.75%-2% in the short term, this market sentiment will be difficult to reverse." Therefore, for investors, each round of US inflation data, employment reports, and statements from the Federal Reserve become signals for judging the yen's trajectory, while also indicating changes in government bond demand and global liquidity. Seth Carpenter, Morgan Stanley's Global Chief Economist and Head of Macro Research, stated, "The key question remains whether the forces driving the yen's depreciation have begun to reverse. We believe the conditions for a reversal are brewing, but have not yet arrived. For the yen, its outlook depends more on the Federal Reserve than on currency intervention or the Bank of Japan itself."
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