Who’s in control of Japanese monetary policy? Tokyo or Washington?

The US Treasury Department's intervention in Japan's foreign exchange market on July 31 marked the first time both nations collaborated to support the yen since 1998. Prior to this, the likelihood of the Bank of Japan raising interest rates during its September 17-18 policy meeting was below 30%. Now, expectations of an increase have surged to nearly 100%.

Bond markets are pricing in a potential one percentage point rise in borrowing costs to 2% by the third quarter of 2027, with JPMorgan predicting Japanese interest rates to reach 2.25% by the end of next year.

US Treasury Secretary Scott Bessent's active involvement in Japan's economic affairs, rooted in his past as a hedge fund manager, has fueled speculation about the terms of their cooperation. Citigroup suggests that US authorities may have received a pledge from the Japanese government to adjust its economic policy, potentially promoting the Bank of Japan's monetary policy normalization.

While Bessent's pressure on Japanese policymakers has caused the yen to strengthen by 4.6% against the dollar since July 28, his claims of "asymmetric information" regarding Japanese policymakers' intentions have been met with skepticism. The intervention, particularly Bessent's blunt tone, is likely to backfire. Japanese policymakers have largely refrained from public comment, but Finance Minister Satsuki Katayama found Bessent's reference to himself as "the house" "a bit scary." If the US meddled in Chinese policymaking similarly, there would be significant repercussions.

Bessent's intervention could have adverse effects on Japan's economy, the Bank of Japan's credibility, and technology-driven stock markets in Asia. Rising borrowing costs may dampen household consumption, which was flat in the second quarter. Moreover, the BOJ's perceived shift towards agressive rate increases could undermine its credibility.

If higher Japanese interest rates prompt the unwinding of the yen carry trade, technology-focused stock markets in South Korea and Taiwan could suffer, and capital may flow away from US Treasury bonds. Overall, while the US pressures Japan's monetary policy, there are risks of global market instability.