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Japan’s Intervention Intentions

Shawn Baldwin from CMG discusses how the Bank of Japan’s currency intervention will affect the Forex market.

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.

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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.

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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.

About the author

Shawn D. Baldwin is Chairman of the AIA Group (AIA), an alternative investment and advisory firm based in Chicago.

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