Japanese Yen Intervention – A Realistic Risk?

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The Bank of Japan has a monetary policy meeting this week and many traders are wondering if they will decide to intervene in the currency market to stop the Yen from rising. First and foremost, it is important to understand that the decision to intervene in the Yen rests with the Ministry of Finance and not the Bank of Japan. The MoF decides if and when to intervene, then directs the BoJ to execute their decision. Even though the Bank of Japan is responsible for selling Yen and buying dollars, they are not the ones that decide if and when it is time to come into the market. So don’t expect this week’s BoJ meeting to result in intervention from the central bank. With this in mind, the fact that USD/JPY is hovering less than 3.5% from its record low means the risk of intervention from the Japanese government is a serious one that limits the downside in USD/JPY.

No Intervention Above 77

The last time the Japanese government intervened in USD/JPY was in November of 2011. The central bank came into the market at least 3 times in March, August and November to weaken the Yen because the strong yen puts significant pressure on the export sector, the lifeblood of Japan. The problem is that external and not domestic forces have been driving the strength of the Yen, so even if the Bank of Japan were to come into the market to sell the Yen, it wouldn’t change the fact that investors don’t want to own U.S. dollars. Furthermore, the Japanese government has had a very poor track record of successfully intervening in its currency. The only time intervention has truly been successful was when the BoJ joined forces with other central banks. Unfortunately, right now, everyone is buried up to their necks in their own problems and need a weak currency. So if the BoJ were to intervene, they would have to go at it alone. The range in USD/JPY that they intervened in last year was between 75.50 and 76.50 so the MoF’s line in the sand is most likely 76. The Ministry of Finance allowed USD/JPY to fall to 77 numerous times last year and this implies there will be no intervention above 77. However if USD/JPY were to fall below 77, the risk of intervention increases exponentially (in the CNBC video below we talk about how to trade BoJ intervention). While the Japanese government is under significant pressure to stop the Yen from rising, they really don’t want to come into the market because they know how futile it will be. Thankfully the rally in USD/JPY on Friday eases some of the pressure to intervene.

Will the BoJ Ease Again?

In lieu of intervention, the Bank of Japan could ease monetary policy. When they surprised the market with a 1% inflation target and an increase in asset purchases in February of this year, they successfully set off a rally in USD/JPY that took the currency pair from 77.50 to 84.15 in one month. Given the recent deterioration in economic data and the slowdown in global growth, the Bank of Japan is widely expected to increase their asset purchase program by JPY10 trillion. However, most economists expect the BoJ to move in October instead of this week because the central bank’s semiannual Outlook Report will be completed and released at that time. Also, it will give the Japanese the opportunity to see how the market reacts to the Federal Reserve and the European Central Bank’s recent actions. If the BoJ were to ease alongside the Fed and the ECB, the surprise would be large enough to drive USD/JPY higher. Even if the central bank doesn’t ease, they are still expected to downgrade their view on exports and their overall assessment of current economic conditions.

New Driver for USD/JPY?

When it comes to USD/JPY, all experienced forex traders know that the main driver of the currency pair’s value are U.S. fundamentals and the market’s appetite for dollars. As shown in the chart below, since the beginning of 2011, there has been a very strong correlation between U.S. 10 year yields and USD/JPY with the former leading the latter. There will come a point where the main driver of USD/JPY will begin to shift and we could be nearing that point soon. Despite the Federal Reserve’s announcement last week, U.S. yields don’t have much more room to fall whereas stocks could continue to rise if the flood of liquidity keeps investors optimistic. At some point, stocks will become a more dominant driver of USD/JPY than yields but only if the risk rally continues.

Kathy Lien
Managing Director

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