FX Weekly - Markets test the line on yen weakness

Market is testing authorities

In July 2026, USD/JPY reached levels last seen in 1986, while EUR/JPY rose to its highest level since the euro was introduced. The yen is widely seen as significantly undervalued. However, its weakness is not just a market anomaly. For many years, Japanese investors have looked abroad for higher returns because very low interest rates in Japan offered few attractive investment opportunities at home. These interest rate differentials are also an important driver of carry trades, with the yen used as funding currency.

More recently, concerns about Japan’s economic policy have put additional pressure on the yen. Prime Minister Takaichi’s focus on fiscal spending, together with pressure on the Bank of Japan not to raise interest rates, has made investors uneasy. Japan is also a major energy importer, so higher oil and gas prices are negative for the economy because they increase import costs.

Japanese authorities have intervened in foreign exchange markets before. However, coordinated intervention with the US is rare. At the end of July, the US and Japan reportedly acted together to support the yen. Japan sold USD/JPY, while the United States sold EUR/JPY. The latter was notable. It suggests that the US may have wanted to limit the impact on the US Treasury market, especially as financial markets appear to be questioning policy under new Fed Chair Warsh.

This type of coordinated action is highly unusual. The last major joint intervention by Japan and the United States was in March 2011, after the Tohoku earthquake and tsunami. Before that, there was an important coordinated intervention in June 1998. The 1998 intervention is notable, because it eventually helped reverse the yen’s downward trend.

For the yen to strengthen on a lasting basis, two things are needed. First, Japan’s economic outlook must change. This would require more confidence in Japan’s economic policy and a smaller interest rate gap between Japan and other major economies. Second, investors need to believe that the yen is unlikely to weaken much further. The recent coordinated intervention seems designed to influence exactly these expectations. However, currency markets are likely to test the authorities again to see whether both the US and Japan are serious about defending these levels. In other words, the US and Japan may need to show more than once that they believe yen weakness has gone too far.

At some point, Japanese investors may decide that domestic assets offer a better balance between risk and return than foreign investments. Such a shift could have important consequences for global financial markets, because Japanese investors hold large amounts of foreign bonds, including US Treasuries. The US is aware of this risk and has little interest in seeing Japanese investors sell large holdings of US government debt and bring the money back to Japan.

EUR/USD: Waiting for clearer direction

EUR/USD is the most liquid currency pair, so many global currency flows pass through it. The yen intervention led to more dollar weakness against the yen than euro weakness, which helped EUR/USD to move higher and rise above 1.15. For now, the 1.1325 to 1.1350 area appears to be a solid support zone. However, the recent increase in oil and gas prices has again limited the upside for the euro. Markets remain volatile and are waiting for new information. This week, that could come from developments in the Middle East and the yen market, but also from important US data releases, including CPI today, PPI tomorrow and retail sales on Friday. These data could lead markets to reassess expectations for the Fed meeting on 16 September. Before then, investors will also focus on the Fed’s Jackson Hole Economic Policy Symposium at the end of August, where Fed Chair Kevin Warsh has indicated that he plans to speak. The ECB will announce its next monetary policy decision on 10 September. Overall, several events in the coming weeks could give currency markets clearer direction.