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The Bank of Japan: A History of Intervention

Before delving into the arguments for and against the Bank of Japan’s intervention in the currency markets, it is important to understand why both analysts and market participants are concerned about a possible intercession this time around. Looking at the chart below, we can see that the Japanese central bank is no stranger when it comes to manipulating the currency market. In the past 10 years, the BoJ has entered the market on three very notable occasions. The earliest effort came back in 1998 after USDJPY rallied over 6,700 points (and nearly doubling 1995’s exchange rate) to a high that lost momentum just before reaching 150. The next time the group stepped into the market was in 2000 around 100. The importance of this level was substantiated when in 2004 the central bank once again entered the market to shore up price action above 100. Whether this is considered a level of equilibrium for the largely export market, or merely a coincidence, it has certainly caught the market’s attention.

Why Intervention is Inevitable:

There are a number of reasons why the Bank of Japan or specifically the Ministry of Finance could intervene in the Japanese Yen other than the fact that it has hit 100, which has always been a point of contention for policy makers:

1. Japanese Corporations are Losing Money:  The most solid argument for the official money market activity is to secure the economy’s place in the global market place. Japan is a major export nation and ships most of its goods to the US and other Asian trade partners. With the yen appreciating consistently against the US dollar, the currency of its largest trade partner, the health of the economy is at stake. According to the recent Tankan survey showed that most Japanese corporations forecast the value of USDJPY in 2008 to be around 113.00.  At 100, their hedges are deep in the red. This is an especially concerning point for policy makers in 2008 as the US is flirting with a possible recession and the Japanese economy is looking at little support from domestic consumption as both consumer confidence and planned business investment are at 5-year lows. Should corporate profitability plummet at this economically delicate time, the Japanese economy could find itself in worse shape than the US.

2. Lowering Interest Rates Not an Option:  If the Japanese government lets the Japanese Yen continue to rise, they will quickly run out of options to stabilize growth.  For the BoJ, lowering rates in an attempt to halt the yen’s advance and correcting credit markets – like the Fed – is unreasonable. Since the benchmark Japanese lending rate is only 0.5 percent, they have limited downside potential for lower rates. What’s more, the market would know the BoJ couldn’t lower rates deeply enough to influence the rally. So, from this standpoint, it would seem the central bank has little choice but to intervene if they don’t want to leave Japan’s fate to the whims of the market.

3. Speculative Position at an Extreme:  If the Japanese government wanted to intervene, no time would be better than the present because positioning in the Japanese Yen is at an extreme, giving them the most bang for their buck. Yen long positions are at the highest levels since Feb 2004, right before the last BoJ intervention. An intervention now would trigger stops, exacerbating the USD/JPY’s rise. 

Why the Japanese Will Wait

1. Leadership Vacuum:  When it comes to the health of the economy and the level of the Japanese yen, the Bank of Japan has a duty to do what it can to promote stability. However, bureaucracy can often be a greater force than one’s duty. For those that believe the currency’s advance requires the Bank of Japan’s hand, the recent political feud over the central bank could not have come at a worst time. A great divide has developed within Parliament over who will succeed current Governor Toshihiko Fukui and his two deputies when they steps down next week on the 19th. The lower house – held by the ruling party – has already passed nominees for all three positions, with Toshiro Muto looking to take the Governorship. However, the opposition held upper parliament has vetoed Muto and one of the deputies – claiming their attachment to the Ministry of Finance would jeopardize the central bank’s independence. So, while lawmakers try to work out this bind, there is likely to be a political freeze on any monetary policy that could polarize the parliament. If there is no decision made on a replacement by next Wednesday, a deputy or bank member will have to stand into the top spot. And, the likelihood of a fill-in making any dramatic decisions is slim.

2. MoF Officials Have Already Denied Need for Intervention: Outside the Bank of Japan’s bind, there have been guarantees made by high ranking officials to assure that there will be no intervention this time around. Vice Finance Minister Shinohara said earlier this week that the current circumstances are different from when they intervened in 2003 and 2004, which is why the current USD/JPY move may not be stressing them out.  

3. Japan is Calling for More Chinese Revaluation:  Another reason officials are unlikely to intervene in the market, is Japan’s ongoing encouragement for China to allow its currency appreciate under market natural market forces. The Chinese Yuan has long been under the express control of the government. Only recently have they loosened the currency peg under global political pressure and oppressive levels of inflation; but China is restraining the yuan’s appreciation. It is in Japan’s best interest for the Chinese currency to appreciate as this improves their competitiveness with cheap goods shipped out of the Asian giant and Japanese exports to China will yield a greater return. However, should Japan intervene in the currency market, it may be labeled manipulation by the still cautious Chinese monetary policy authority and hamper a shift towards more liberal exchange controls.

Where will the Yen go?

While it is unclear whether the Bank of Japan will intervene in the market or not, the outcome for the both scenarios is rather clear. Should the central bank hold the sanctity of the 100 level, the yen could quickly tumble, allowing for a recovery in USD/JPY. A strong rebound could easily build momentum from a captivated speculative market which is ready for a sharp turn on what many would consider strong, psychological support. Positioning in the market certainly confirms this outlook. The Commitment of Traders Report has reported a historical high in speculative yen long positions, and reversals are usually seen at these extremes. On the other hand, if the policy authority chooses to ignore the yen’s advance, risk aversion and carry trade unwind could easily carry though the otherwise notable level. Sentiment also supports follow through. FXCM’s Speculative Sentiment Index jumped to 2.46 with nearly 71 percent of retail traders holding long positions. Retail traders are often on the wrong side of the trade. So, no matter the outcome, volatility should be expected.

The USDJPY broke traded below 100 today for the first time since October 1995.  More importantly, the pair broke below waves b and d of the long term triangle.  This supports our long term call for price to drop below the 1995 low of 81.12.  However, we do expect a rally near term.  There are 9 waves down from 103.58 (which we are treating as the end of wave 4 on the chart above).  Therefore, expect a rally to at least 101.69 and possible higher near term.

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