The battle to defend the 29 trillion US debt has begun! The US Treasury Secretary personally stepped down to “save the yen,” and the Federal Reserve may be forced to start a new role in “financial diplomacy”

The Zhitong Finance App notes that the Federal Reserve may soon be involved in the Trump administration's actions to support America's ally Japan, a currency in trouble.

US Treasury Secretary Bezent hopes that the US Federal Reserve, which remains politically neutral, will expand a loan mechanism to enable Japan to support its currency without disturbing the sensitive US Treasury bond market. The request comes as new Federal Reserve Chairman Kevin Walsh is seeking to reshape the relationship between the Treasury and the Federal Reserve.

The way the two cooperate is likely to have a significant impact on the management of this $29 trillion treasury bond market, and may enable the Federal Reserve to take on a new role in supporting US financial diplomacy.

It is currently unclear how much support has been received by the Federal Reserve Chairman for major policy changes within the Federal Reserve.

Bessent posted on the X platform on Sunday that the US has interfered in the foreign exchange market to support the yen. It has long been routine for Japan to intervene in its long-weakened currency, yet US participation is extremely rare. Following the devastating earthquake and tsunami in 2011, the United States joined a broader effort to support Japan.

The yen has fallen sharply since 2022, when the US raised interest rates sharply and Japan did not follow suit. Economists have debated the factors behind the decline, but these include huge debts issued by the Japanese government, a shrinking and aging population that is dragging down growth prospects, and recent expensive energy imports. Weak currencies can trigger inflation by making imports more expensive, and the Japanese government has expressed concern about this issue many times.

According to Factset data, there was a situation last week where 1 dollar could be converted to nearly 164 yen, which is the pair's lowest level since 1986.

Subsequently, the United States joined forces with the Japanese authorities to try to back down the yen. “Coordinated foreign exchange action on Friday contained disorderly fluctuations in the yen,” Basent said on Sunday. The Ministry of Finance sold the euro in its Exchange Stabilization Fund to finance the purchase of yen. As of Monday afternoon US time, the yen had rebounded from a low of 3.5% to slightly below 157.

The purpose of this action may also be the treasury bond market. Interest spreads between Japan and the US facilitate long-standing “arbitrage transactions” — investors borrow yen at low cost and invest in higher-yielding US Treasury bonds or the AI-driven US stock market boom.

But the future of such a deal is being questioned. President Donald Trump's tariffs and other policies have prompted global investors to hedge their dollar deals.

Apollo Global Management's chief economist Thorsten Slocke wrote in a research report released on Sunday: “The Japanese yen arbitrage transaction has broken down.”

Stopping the yen's fall could reinforce arbitrage trading and help maintain demand for US Treasury bonds. When financial institutions, governments, or central banks sell treasury bonds, treasury bond prices fall and yields rise.

Prior to the intervention, the 10-year US Treasury yield rose above 4.7% last week and then fell slightly below that level. High US bond yields are making it more expensive for consumers and businesses to borrow. Bezent has said he is closely monitoring 10-year US Treasury yields.

The way Bezent intervened also showed that he took the US debt market into account. His department sells euros rather than dollars to buy yen. He also said that looking ahead, he would like to see Japan use the Federal Reserve's borrowing tool called the “Foreign and International Monetary Authority (FIMA) Buyback Mechanism.”

The FIMA mechanism allows foreign central banks to borrow on their US Treasury holdings in the short term instead of directly selling treasury bonds. This avoided political and economic problems caused by rising treasury yields.

Central banks often support actions to stabilize the global financial system in times of tension. However, under these circumstances, it is currently unclear whether the long-term pressure faced by the yen constitutes such concerns about the liquidity or operation of the market.

For example, Japan has the right to use the Federal Reserve's currency swap mechanism, which allows Tokyo to exchange yen for dollars. However, Japan did not use this mechanism this time.

Brad Seiser, a former Treasury official currently serving on the US Foreign Relations Commission, wrote in a post on the X platform, “The current practice is that central bank swaps are used to provide dollar funding for lender type activities of last resort, not foreign exchange intervention.”

In his X post, Bessent said he would like to see FIMA “scaled up.” The buyback mechanism places a daily limit of $60 billion per counterparty. As of May, Japan held approximately $1.1 trillion in US Treasury bonds, according to US data. The scale of Japan's recent intervention is estimated to be between $60 billion and $80 billion.

If the FIMA mechanism is applied more widely, it can make the treasury bond market more attractive, thereby easing US fiscal pressure broadly.

This idea may have broad political and economic appeal, but it doesn't necessarily fall within the Federal Reserve's purview. Expanding FIMA requires a Federal Open Market Committee (FOMC) vote.

Walsh probably thought it was worth it. Prior to taking office as chairman, he said he wanted to rewrite the relationship between the Federal Reserve and the Treasury known as the “Treasury-Federal Reserve Agreement.”

In response to questions from Democratic senators during the April confirmation process, he indicated that the Federal Reserve may want to make concessions to the Treasury on similar issues. Walsh wrote, “In fields involving international finance, etc., Federal Reserve officials do not enjoy the same special respect. The Federal Reserve will cooperate with the government and Congress in these matters.”

The renewed collaboration between the Federal Reserve and the Treasury Department may extend to other areas. The United Arab Emirates has applied for its own currency swap line, which is usually a matter for the Federal Reserve to decide. Walsh's views on making concessions to the Treasury suggest that he may be open to considering extending the currency swap line to new countries. And he's already working closely with Bezent.

Walsh said in the Senate that in addition to the regular weekly breakfast meeting between the Chairman of the Federal Reserve and the Treasury Secretary, the two also communicate frequently.