4 Reasons Why BoJ Hasn’t Intervened in USDJPY

Intervention Japanese Yen Kathy Lien

We have now seen the dollar fall approximately 600 pips against the Japanese Yen in just over week.  Alarms should be ringing at the Ministry of Finance and Bank of Japan because the 5% appreciation spells big trouble for Japan’s businesses and economy. However, everything that we have heard from the Japanese government so far suggests that they are not ready to intervene in the foreign exchange market to lower the value of their currency. The last time the Bank of Japan intervened in the currency was in 2011 after the earthquake and tsunami (and that was coordinated). Since then we have seen USDJPY fall as low as 76 and average around 102.25 over the past 4 years. So Japan has and can tolerate a stronger yen although they have less flexibility with monetary and fiscal policy because extensive action has already been taken through these years.

While we believe the Japanese government should intervene given the weakness of the currency, there are a number of reasons why they won’t:

  1. They could be waiting for the G7 meeting
  2. They could be waiting for fresh fiscal stimulus
  3. They could be waiting for the markets to capitulate first.
  4. They could also be looking into monetary stimulus rather than direct intervention to avoid being singled out for competitive devaluation of their currency at the G7 meeting in late May – because the host never wants to be embarrassed.

On a fundamental basis, it is becoming clear that the BoJ could allow USD/JPY to fall to 105 and maybe even 100 before taking action. In early February they let USD/JPY fall close to 1100 pips before there was also indication of intervention. While it has not been confirmed on February 11th, after dropping to a low of 110.98, USD/JPY jumped 200 pips in 20 minutes -- price action that is indicative of intervention. USD/JPY still has 500 pips to go before this capitulation point, which would put the pair right between the 100 and 105 level. However we would be surprised if the BoJ let USD/JPY fall 1000 pips from its March 29th high of 113.80 without checking rates near 105.

On a technical basis, there’s no support in USD/JPY until 106.63, the 38.2% Fibonacci retracement of the 2011 to 2015 rally. We expect USD/JPY to test and bounce off this level. However if the Fib is broken then it should be smooth sailing down to 105.85, the 200-month SMA. So while the Bank of Japan could allow USD/JPY to drop 1000 pips from its recent high, there are enough key technical and psychological support levels between now and then to make it a choppy and not one-way move.

usdjpy040716.png

Japanese Intervention was Not Sterilized – What Does that Mean?

Bank of Japan forex blog Intervention Japanese Yen Kathy Lien

The Bank of Japan said explicitly last night that their intervention will NOT be sterilized. This is VERY good because it gives their intervention efforts a greater chance of succeeding.

Intervention by central banks is one of the most important short-term and long-term fundamental drivers in the currency market. For short-term traders, intervention can lead to sharp intraday movements on the scale of 150 to 250 pips in a matter of minutes. For longer-term traders, intervention can signal a significant change in trend because it suggests that the central bank is shifting or solidifying its stance and sending a message to the market that it is putting its backing behind a certain directional move in its currency.

There are basically two types of intervention, sterilized and unsterilized. Sterilized intervention requires offsetting intervention with the buying or selling of government bonds, while unsterilized intervention involves no changes to the monetary base to offset intervention.

The intervention by the Japanese government in 2003-2004 was sterilized which is part of the reason why it was unsuccessful. The government sold Yen with money financed by the issuance of bills. When intervention is not sterilized, the money supply is increased because the funds used to sell Yen may be raised by printing money.

Many argue that unsterilized intervention has a more lasting effect on the currency than sterilized intervention and thankfully the latest intervention is not sterilized.

Quoting the Cleveland Federal Reserve who published a working paper titled Sterilized Intervention, Nonsterilized Intervention, and Monetary Policy in 2001:

Sterilized intervention is generally ineffective. Countries that conduct monetary policy using an overnight interbank rate as an intermediate target automatically sterilize their interventions. Unsterilized interventions can influence nominal exchange rates, but they conflict with price stability unless the underlying shocks prompting them are domestic in origin and monetary in nature. Unsterilized interventions, however, are unnecessary since standard open-market
operations can achieve the same result.

How is Intervention Sterilized?

According to the Cleveland Federal Reserve, this is how the sterilization of intervention is done:

Sterilization occurs automatically by virtue of the Federal Reserve’s operating procedure. The FRBNY’s Open Market Desk manages total reserves in the U.S. banking system in such a way as to achieve the federal funds target that the Federal Open Market Committee (FOMC) establishes in its monetary-policy deliberations. The FOMC actions are almost always taken with domestic objectives—inflation, business-cycle developments, financial fragility—in mind. Given its estimate of depository institutions’ demand for total reserves, the Desk manages the supply of reserves through open-market operations to keep the actual federal funds rate at the target. In the process, the Desk must take account of a number of factors that appear on the Federal Reserve’s balance sheet and that can affect the amount of reserves in the banking system at any time. Among these items are changes in the Treasury’s cash balances and changes in the Federal Reserve’s portfolio of foreign exchange. The Federal Reserve staff will attempt to estimate these on a day-to-day basis, but whether anticipated or not, the Fed will respond to them quickly in defense of the federal funds target. Consequently, intervention is never permitted to change reserves in a manner that is inconsistent with the day-to-day maintenance of the federal fund rate target. All central banks, including the Bank of Japan and the European Central Bank, that use an overnight, reserve-market interest rate as a short-term operating target necessarily sterilize their
interventions in this way.

The Federal Reserve has on occasion adjusted its monetary policy stance with an exchange market objective in mind, and it has sometimes intervened in the foreign exchange market while altering its federal funds target. Whether one refers to such interventions as nonsterilized or as a combination of a sterilized intervention in conjunction with a monetary policy change is inconsequential. In either case, the intervention is completely unnecessary since domestic open-market operations alone can achieve the same objective.

G7 Statement on Coordinated FX Intervention

forex blog Intervention japan quake yen Kathy Lien

18 March 2011 -- Statement of G7 Finance Ministers and Central Bank Governors

We, the G7 Finance Ministers and central bank governors, discussed the recent dramatic events in Japan and were briefed by our Japanese colleagues on the current situation and the economic and financial response put in place by the authorities.

We express our solidarity with the Japanese people in these difficult times, our readiness to provide any needed cooperation and our confidence in the resilience of the Japanese economy and financial sector.

In response to recent movements in the exchange rate of the yen associated with the tragic events in Japan, and at the request of the Japanese authorities, the authorities of the United States, the United Kingdom, Canada, and the European Central Bank will join with Japan, on 
18 March 2011, in concerted intervention in exchange markets. As we have long stated, excess volatility and disorderly movements in exchange rates have adverse implications for economic and financial stability. We will monitor exchange markets closely and will cooperate as appropriate.

What is Sterilized Intervention?

Intervention Kathy Lien sterilized intervention unsterilized intervention

Intervention by central banks is one of the most important short-term and long-term fundamental drivers in the currency market. For short-term traders, intervention can lead to sharp intraday movements on the scale of 150 to 250 pips in a matter of minutes. For longer-term traders, intervention can signal a significant change in trend because it suggests that the central bank is shifting or solidifying its stance and sending a message to the market that it is putting its backing behind a certain directional move in its currency.

There are basically two types of intervention, sterilized and unsterilized. Sterilized intervention requires offsetting intervention with the buying or selling of government bonds, while unsterilized intervention involves no changes to the monetary base to offset intervention.

The intervention by the Japanese government in 2003-2004 was sterilized which is part of the reason why it was unsuccessful. The government sold Yen with money financed by the issuance of bills. When intervention is not sterilized, the money supply is increased because the funds used to sell Yen may be raised by printing money.

Many argue that unsterilized intervention has a more lasting effect on the currency than sterilized intervention.

Quoting the Cleveland Federal Reserve who published a working paper titled Sterilized Intervention, Nonsterilized Intervention, and Monetary Policy in 2001:

Sterilized intervention is generally ineffective. Countries that conduct monetary policy using an overnight interbank rate as an intermediate target automatically sterilize their interventions. Unsterilized interventions can influence nominal exchange rates, but they conflict with price stability unless the underlying shocks prompting them are domestic in origin and monetary in nature. Unsterilized interventions, however, are unnecessary since standard open-market
operations can achieve the same result.

How is Intervention Sterilized?

According to the Cleveland Federal Reserve, this is how the sterilization of intervention is done:

Sterilization occurs automatically by virtue of the Federal Reserve’s operating procedure. The FRBNY’s Open Market Desk manages total reserves in the U.S. banking system in such a way as to achieve the federal funds target that the Federal Open Market Committee (FOMC) establishes in its monetary-policy deliberations. The FOMC actions are almost always taken with domestic objectives—inflation, business-cycle developments, financial fragility—in mind. Given its estimate of depository institutions’ demand for total reserves, the Desk manages the supply of reserves through open-market operations to keep the actual federal funds rate at the target. In the process, the Desk must take account of a number of factors that appear on the Federal Reserve’s balance sheet and that can affect the amount of reserves in the banking system at any time. Among these items are changes in the Treasury’s cash balances and changes in the Federal Reserve’s portfolio of foreign exchange. The Federal Reserve staff will attempt to estimate these on a day-to-day basis, but whether anticipated or not, the Fed will respond to them quickly in defense of the federal funds target. Consequently, intervention is never permitted to change reserves in a manner that is inconsistent with the day-to-day maintenance of the federal fund rate target. All central banks, including the Bank of Japan and the European Central Bank, that use an overnight, reserve-market interest rate as a short-term operating target necessarily sterilize their
interventions in this way.

The Federal Reserve has on occasion adjusted its monetary policy stance with an exchange market objective in mind, and it has sometimes intervened in the foreign exchange market while altering its federal funds target. Whether one refers to such interventions as nonsterilized or as a combination of a sterilized intervention in conjunction with a monetary policy change is inconsequential. In either case, the intervention is completely unnecessary since domestic open-market operations alone can achieve the same objective.

SNB Intervenes in the Swiss Franc!

eurchf Intervention Kathy Lien swiss national bank

Last week we raised the question of what the Swiss National Bank is waiting for and why they haven’t intervened. In that article we said “Everyone has an uncle point and for the SNB there is no question that we are nearing that level…” At that time, EUR/CHF was trading at 1.4272 and apparently today’s record low of 1.4144 was all the SNB could handle!

They have denied to comment on the move in the Swiss Franc but a 265 pip rally EUR/CHF in under 6 minutes is exactly the type of move that only occurs when there is intervention. Most likely, the SNB had their buy orders sitting were right below 1.4150. Judging from the price action in EUR/CHF after interventions last year, the rally will probably not last particularly since the central bank is talking about raising interest rates.

Why the SNB Has Not Intervened in the CHF

eurchf forex blog Intervention Kathy Lien swiss national bank

For the eighth trading day in a row, EUR/CHF has failed to rally. The Swiss Franc even ended the day at a fresh record high against the euro as traders test the resolve of the Swiss National Bank. This has led many currency traders to wonder What is the SNB Waiting For? Why haven’t they intervened?

The problem is that even though the central bank has been warning about intervention, they have also been talking about raising interest rates. Over the past year, a lot of traders have sold Swiss Francs as a funding currency because of its low yield and now the prospect of a rate hike will force them to unwind their short CHF positions. Although intervention risk is exceptionally high at this time, the reason why the SNB has not intervened yet is because we are in a very different place now than in March 2009.

When the global financial crisis hit, there was a tremendous amount of deleveraging in which investors bought back Francs and closed their positions. Many Swiss banks also reduced their balance sheets, leading to downside pressure on EUR/CHF. In fact, net capital flow into Switzerland hit a record high last year. As a result, EUR/CHF fell aggressively at a time when the financial crisis was still unfolding, forcing the SNB to step into the market to weaken the Franc. The central bank intervened 3 times last year from what I can tell – in March, June and September. Since then, the global economy has stabilized, Switzerland came out of recession and the economy is improving.

With less to fear, the SNB has remained out of the market opting for verbal versus physical intervention. The trade surplus is a lot higher than last year and exports remain at healthy levels, reducing the need for intervention. Forex traders love to test the resolve of a central bank and I continue to expect them to do so until the SNB actually steps in. Everyone has an uncle point and for the SNB there is no question that we are nearing that level but as we have seen in the recent price action, betting on a move by the central bank can require deep pockets.

Why USD/JPY Could Continue to Fall

forex blog Intervention Japanese Yen Kathy Lien

Last Friday, the CFTC released their weekly report of futures positioning. According to the data, which was as of last Tuesday, short positions in the Japanese Yen hit the highest levels since August 2008. At that time, the Yen weakened significantly and soon after a short squeeze pushed the currency sharply higher against the U.S. dollar.

The following chart illustrates the strong relationship between Yen positions and the JPY/USD (the inverse of USD/JPY). Right now the Yen is rising against the dollar despite the fact that traders are substantially short Japanese Yen. This means that should the Yen continue to rise, or in other words USD/JPY continues to fall, there could be an aggressive short squeeze that triggers a big move higher in the Yen and a sharp breakdown in USD/JPY.

A further rally in the Yen will undoubtedly test the resolve of Japan’s Ministry of Finance and at some point, maybe below 87, the Japanese government may feel compelled to step in and vocally criticize foreign exchange fluctuations but until then, the odds are skewed towards further losses in USD/JPY.