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Japan Has a Pile of Dollars It Can Tap Before Selling Treasuries

·3 min read

(Bloomberg) -- The risk of Japanese currency intervention spilling over and causing undue disturbances in an already under-fire US Treasury market is smaller than it once was thanks to tools that the Federal Reserve now has in place to make sure the market has enough dollars and places to park them.

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Japan on Thursday intervened to prop up the yen for the first time since 1998 and to do so it had to get its hands on dollars to sell. Once upon a time it might have needed to liquidate Treasuries to raise the requisite cash -- but that’s not necessarily the case any more.

The Fed’s creation of a reverse repurchase agreement facility that’s accessible by foreign central banks means that international monetary authorities such as the Bank of Japan can keep a big chunk of their cash there earning interest instead of in Treasury bills and other securities. And when they need to do something with those dollars, they can just withdraw it from the Fed facility without ruffling markets.

While Treasuries did sell off on Thursday in a bear-steepening move, participants pointed to an ongoing digestion by the market of the Fed policy message from a day earlier as being a significant driver, rather than any particular liquidation by foreign holders.

As with the domestic reverse repo facility, the so-called foreign RRP is a place where counterparties can stick their cash overnight with the US monetary authority. And that cash earns a rate that’s generally equivalent to the offering yield on the New York Fed’s domestic facility, making it a more than palatable alternative to a lot of market-based short-end instruments.

Yen Intervention Has Powerful But Fleeting Impact

Foreign institutions currently have about $295 billion stashed there at the moment, according to Fed data for the period through Sept. 21, down from $301 billion a week earlier.

Wall Street strategists estimate that the BOJ has more than $110 billion in the Fed’s Foreign and International Monetary Authorities repo pool that could be deployed before it has to liquidate Treasury holdings. By comparison, when Japan intervened to strengthen the yen in 1997-1998, the government sold roughly $42 billion, with about $26 billion coming on one day in April 1998, according to data from the nation’s Ministry of Finance.

“If you’re the Bank of Japan, the first hit is the Fed’s FIMA reverse repo pool,” said Blake Gwinn, head of US interest rates strategy at RBC Capital Markets. “It’s costless, you’re not going to take the risk. If you’re the BOJ selling at these levels on the curve right now, you’re taking a capital loss.”

If the intervention were to exceed the amount parked at the US central bank, policy makers could start selling Treasuries, though it would likely be very short-dated securities, maturing under two years.

The MOF had about $1.29 trillion of official reserve assets as of August, the latest data show. Of that, the government holds about $1 trillion in securities, $135 billion in the form of either cash or bank deposits and $155 billion in other assets. And the bank deposits are split between various foreign banks, including the Fed, and the Bank for International settlements.

If the fallout from Japanese yen intervention was to have any impact on US rate markets, it may be a tightening effect on shorter dated dollar swap spreads, Bank of America strategists wrote in a note dated Sept. 9 in which they discussed yen intervention risk. On Thursday, two-year swap spreads tightened more than 3 basis points before retreating, but remained largely within the range from the prior day.

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