Ongoing trouble with the Japanese yen prompted an unusual intervention by the federal government in August, who acted to strengthen the troubled currency so as to avoid a painful market correction that could have spilled out into the broader global economy.
The trouble began in 2022, when the post-pandemic inflation experienced throughout the world began creeping into the island nation. While inflation itself is not abnormal and can often be desirable, Japan is a bit of an outlier on the world stage in that its economy has experienced almost no inflation for decades.
Economists still debate exactly why that is, but most believe several economic forces reinforced one another to create this peculiar condition. After the collapse of Japan's enormous stock and real estate bubble in the early 1990’s, Japanese households, businesses, and banks spent years repairing their balance sheets rather than borrowing and investing.
At the same time, an aging population, sluggish wage growth, cautious corporate behavior, and persistent expectations that prices would remain flat all worked to suppress demand. Together, these pressures appear to have caught Japan in a low-inflation equilibrium, where weak demand discouraged price increases, and the absence of inflation reinforced the expectation that costs would remain stable.
Over time, that became the normal state of the Japanese economy, shaping monetary policy for nearly three decades. But that equilibrium was upended by the pandemic. Like most western countries, Japan injected its economy with liquidity during the shutdown to keep things functioning.
The influx of money naturally created some levels of inflation on its own, but this was amplified by the conflicts in Ukraine and Iran. The Japanese are heavily reliant on imports of both food and energy, and these commodities were significantly disrupted by their respective wars.
That means their prices went up, and starting in 2022, Japan began experiencing sustained levels of inflation for the first time in decades. This also happened in the United States and attempts to alleviate this inadvertently placed additional pressure on the yen. Beginning that same year, the Federal Reserve began hiking the overnight rate to combat domestic inflation.
But the result was a historically wide gap between borrowing costs in Japan and investment returns available in the United States. Investors could now borrow the yen at ultra-low rates, exchange it into dollars, then put that money into investments offering a much higher yield.
This is often called a carry trade and it’s a pretty sweet deal if the yen stays stable, but you can lose your shirt if it doesn’t. That’s because if the value of the yen rises, your return diminishes. Here’s an extremely simplified example: let’s say ¥100 is equal to $1, and you borrow ¥100 billion. You convert that to $1 billion and buy treasuries with a five percent annual yield.
One year later, your treasuries are worth $1.05 billion. Not bad, but in that same time frame, suppose the yen has strengthened. Now the exchange rate is ¥80 to $1, and it takes $1.25 billion to purchase your yen back and repay the loan. So, despite earning $50 million on the treasuries, you actually lose $200 million during the currency exchange.
There’s a flip side to this: Suppose the yen weakens. Your $1 now buys $120 yen. Your billion dollars is now worth ¥126 billion yen; ¥26 billion more than the loan you originally took out. That’s great for you, but at scale its decidedly not great for the Japanese economy.
That’s because if enough investors conclude the yen is likely to weaken further, more capital will flow into yen-funded positions like carry trades, placing additional downward pressure on the currency, which leads even stronger levels of inflation.
And this was, in fact, happening at scale. After 2022, the Japanese yen weakened almost in lockstep with rising U.S. Treasury yields, strongly suggesting investors were responding to the same economic incentive: borrow cheap in Japan and seek higher returns in the U.S.
A 2024 Bank for International Settlements (BIS) study found that the widening U.S/Japanese interest-rate gap after 2022 also coincided with a dramatically increased use of the Japanese yen as a funding currency. The BIS estimated that outstanding foreign-exchange swaps, forwards, and currency swaps involving the yen grew to roughly ¥2 quadrillion (about $14.2 trillion) by the end of 2023. Pulling that same dataset now, one can see that the outstanding yen-linked FX derivatives continued climbing after that report’s publication, reaching approximately ¥2.77 quadrillion by the end of 2025.
The most striking finding is not that yen-linked FX derivatives grew rapidly through 2023, but that the trend continued to accelerate afterward. Using the same dataset, outstanding yen-linked FX derivatives expanded by more than 53% in yen terms between the end of 2022 and the end of 2025, while the dollar value of those positions also rose steadily each year.
So, whatever forces were increasing the yen's role as a global funding currency did not disappear after the BIS published its analysis; they became even more pronounced, placing additional pressure on the yen itself. And this year, the yen’s value against the dollar reached the point where the Japanese government felt the need to intervene.
As the yen fell through ¥160 per dollar in late April, Japan took the rare step of intervening in the foreign-exchange market. The Ministry of Finance sold dollars from its foreign-exchange reserves and used the proceeds to buy yen on the open market. The move briefly strengthened the currency, but the effect quickly faded. Days later, Japan intervened again, spending a record ¥11.73 trillion (about $74 billion) attempting to stabilize the yen.
It didn’t work. In July, the yen reached a new 40 year low against the dollar and this is when the United States joined Japan in a rare coordinated intervention. Acting through the Federal Reserve Bank of New York, the U.S. Treasury entered the foreign-exchange market and purchased yen alongside Japanese authorities, marking the first joint U.S.-Japan effort to support the currency in nearly three decades.
Treasury Secretary Scott Bessent later stated that Washington was prepared to "do whatever it takes" to help stabilize the yen. That’s strong language, and by stepping into the market after Japan's own interventions had failed, Washington was effectively declaring that the stability of the yen had become a strategic interest of the United States.
And from Washington's perspective, the greatest danger was not a weaker yen itself, but the possibility that it could trigger broader financial instability. Bessent also cited the Asian financial crisis as a reminder that severe yen weakness can spill beyond Japan's borders, making currency stability a strategic interest for the United States.
The International Monetary Fund has also highlighted this risk. Japan's financial system is deeply intertwined with global markets. As one of the world's largest holders of foreign assets and government securities, changes in Japanese financial conditions can transmit quickly abroad through bond markets, capital flows, and investment portfolios.
A disorderly adjustment in the yen or Japanese financial markets could easily ripple into U.S. markets, raising volatility and disrupting the flow of capital between two of the world's largest economies.
Whether the coordinated intervention ultimately succeeds remains an open question. The forces that drove investors toward yen-funded financing have not disappeared, and the same incentives that existed before the intervention continue to shape global capital flows.
Going forward, three indicators should be monitored: the interest-rate gap between the United States and Japan, the value of the yen against the dollar, and the growth of yen-linked funding in global financial markets. If those trends begin to reverse, it suggests the pressure has eased. If they continue moving in the same direction, policymakers may once again find themselves confronting the same forces that prompted one of the most extraordinary, coordinated currency interventions in decades.
