Japan's Intervention Intentions

The Japanese Yen fell from its15 year high against the greenback as the dollar soared reaching a high of ¥83.38 as the rumors of intervention by the Bank of Japan (BOJ) accelerated speculation amongst traders. The USD traded 83.6 as traders anticipated that the BoJ to would add more liquidly to the markets, although the general consensus initially considered additional easing highly unlikely.

The heightened speculation was warranted.

When the Asian currency fell from its 15-year high against the U.S. dollar in mid-September, Japan took unilateral action to weaken currency. The general consensus is that this round of interventions was politically motivated. Newly elected Prime Minister Naoto Kan had pledged action after his election, prompting the first Japanese government intervention in six years.

The Japanese government sold some ¥2.125 trillion yen ($25.46 billion), on September 15, 2010, in an attempt take the currency out of orbit and bring it back to earth. This intervention immediately caused the yen to drop 3%. Kan pushed for the intervention --when most thought he wouldn't-- most likely as a measure to assuage the supporters of his opponent after narrowly winning a fight that threatened his political career. From a nationalistic standpoint the move makes sense, as I explained in Say Yes to the Yen-- Japanese exports are hurt by the yen's strength because it aggravates existing disinflationary forces. This causes the rising yen to be a drag on business sentiment which weighs heavily on the labor market conditions and affects consumer spending.

Mr. Kan's intention's are clear: he wishes to stem the risks for deflation and visibly support the export led recovery. Mr. Kan stated that his administration aims to achieve primary-balance surplus by fiscal 2020 through 1) tax reforms, 2) an increase in the consumption tax.

So expect the BoJ to closely cooperate with the government and take further necessary policy actions to end deflation, which will more than likely mean additional easing measures due to increased pressures by Japanese policy makers for a second time this year. Expect the exchange rate to continue to trend lower over the near-term as the bearish sentiment underlying the U.S. dollar carries into October. The BoJ is widely expected to hold the benchmark interest rate at 0.10% and may look to expand its lending program given the ongoing slack within the real economy.

The potential for increased volatility in the exchange rate will be high as investors weigh the likelihood of future policy. This will undoubtedly prompt speculation among currency investors as to whether the BOJ will Japan is still willing to enter the market again so soon.

There is the possibility of another spike ahead of the decision due to speculation of traders expecting additional quantitative easing. One of the key drivers in speculation is the sheer size of the market, daily market turnover for dollar/yen trading averaged over $568-billion in April. According to Bloomberg reports this is about 14% of total daily trade in all currencies which is currently $3,981Trillion.

Additional fuel for the speculative fire is that the dollar has fallen due to market expectations that the Fed will ease monetary policy and buy heavily to aid the U.S. economy. Given the recent meeting agenda of President Obama and Prime Minister Kan's last visit which was conspicuously light discussion on intervention--do not expect the U.S. to participate when it is focused on coercing China to let the yuan rise without manipulation. Without coordination these efforts are rarely successful on a long term basis. Japan's unilateral intervention will not successfully stymie the yen's rise, which is invariably driven by dollar weakness. However the exchange rate may continue to trend lower over the near-term as the bearish sentiment underlying the U.S. dollar carries into October. If the pair continues to trend lower as traders are long, there might be a key breech of the yearly low as the dollar-yen continues on its downward trend.

A dramatic reduction in the yen against the dollar on Friday caused many to believe that Japan had intervened again in an attempt to circumvent the yen's strength from derailing the recovery--we refer to this as a "failed intervention spike" this is reflected on the dollar-yen chart which was similar to the spike from the first intervention. This was caused by rumors of intervention and sundry political murmurings. Traders in Tokyo assumed that the drop was due to intervention. The yen quickly returned due to the dearth of buyers close to levels where intervention is a possible event (read as highly likely) ¥83.25.

Expect the central bank to announce measures outlining stimulation of the domestic economy, this will most likely mean additional Japanese Government Bonds (JGB) purchases or an extension of the ¥30 trillion credit program to stimulate lending. If this occurs it will create liquidity which will reduce the speculative onslaught that the yen will go higher. Contrarily, if the BoJ does not increase its government bond buying program, it could disappoint the markets, leading to further strengthening of the currency. Traders should expect action from the BOJ if dollar falls below 83 yen.

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