Markets continued to view the joint US-Japan interventions largely through the lens of Tokyo’s struggle to arrest the JPY’s decline, paying insufficient attention to the potentially negative implications for US Treasury holdings and the USD. JPY bears may be underestimating a sharp shift in the monetary policy calculus. Market odds of a September Bank of Japan rate hike have surged to 81% from 21%, while expectations for a Fed hike have plummeted to 32% from 72%.



The divergence is also political. Japan’s Prime Minister Sanae Takaichi has become more supportive of raising interest rates to stabilize the JPY amid lower approval ratings and rising cost-of-living pressures. Conversely, US President Donald Trump is brushing aside his low ratings and telling Americans to accept higher prices in his push for a victory in the Middle East, even as he quietly desires the Fed to lower borrowing costs.

More troubling for the USD was the rise in US long-term bond yields despite negative nonfarm payrolls, a monthly decline in retail sales, and slower year-on-year CPI and PPI inflation. At last Friday’s 30-year Treasury bond auction, investors demanded a yield of 5.216%, the highest since 2001, as compensation for mounting fiscal risks. The US budget deficit is projected to exceed $2 trillion (6% of GDP) in FY 2026 (Oct-Sep), reflecting tariff refunds, higher defence spending, and tax cuts under Trump’s One Big Beautiful Bill.

Markets should not misread US Treasury Secretary Scott Bessent’s request to the Fed to expand the Foreign and International Monetary Authorities (FIMA) Repo Facility from the current limit of $60 billion per counterparty borrowing limit for a JPY-negative development. Washington recognised Tokyo’s increasingly determined and coordinated efforts to defend the JPY, with unwanted spillovers into the US bond market. By publicly keeping the door open to another coordinated operation, Bessent has given Tokyo the political cover to make it costly for JPY bears to hold their short JPY positions.

Fed Chairman Kevin Warsh has added another layer of uncertainty. Markets were unsettled by his July FOMC remark that “the markets are doing the tightening,” particularly as the Fed retreats from forward guidance while continuing quantitative tightening. Hence, rising long-term yields increasingly reflect a higher fiscal risk premium rather than an exceptional US economic narrative that supports Fed-hike expectations.

That puts the Kansas Fed’s Jackson Hole Symposium scheduled for August 27-29 firmly in focus. Rather than reinforcing the USD’s haven credentials, the gathering could expose the policy uncertainty facing US bondholders due to limited forward rate guidance amid heavy Treasury issuance. The five task forces that Warsh appointed in June to review the Fed’s monetary policy framework are not expected to deliver their final findings until the end of the year. Warsh could nevertheless use the recent run of softer-than-expected US data to bolster his case to end forward guidance by questioning the usefulness of the dots, namely, the 9 of 18 Fed participants who pencilled at least one hike for 2026 at the June FOMC meeting.

Beyond Jackson Hole and the September FOMC, US politics could become an increasingly important driver. The Trump administration faces mounting political headwinds ahead of the November 3 midterms. President Trump’s approval ratings have dropped to historically low levels. Polls suggest roughly three-quarters of Americans believe the administration is not sufficiently focused on the domestic economy, particularly higher gas prices and broader cost-of-living pressures. Trading may pivot from the tail risk of a global energy shock towards the political constraints on further military escalation against Iran.



Despite USD/JPY’s recovery from its 155 low on August 3 to 159 last week, the JPY is still 2.5% stronger from its pre-intervention levels. Markets cannot rule out more interventions in USD/JPY around or above the pivotal 160 level. The CAD’s appreciation also reflected the USD’s underlying weakness despite the sharp pullback in expectations for a September Bank of Canada hike and the looming threat of new US tariffs. GBP’s resilience was also noted despite a sudden change in Prime Minister, becoming the only DXY currency to appreciate in 2026.

Overall, fading Fed-hike expectations, persistent US fiscal concerns, and elevated US long-term Treasury yields risk weakening the link between higher US yields and a stronger USD. Speculators with large short USD positions are standing on fragile ground.

Quote of the Day
“All animals are equal, but some animals are more equal than others.
     George Orwell

August 17 in history
George Orwell published Animal Farm in 1946.

The FX Daily will take a break this week and return on August 24.