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FX Intervention: Will the BoJ, ECB, & RBNZ Try to Stop the Dollar's Decline?

Monday, 10 March 2008 17:24:41 GMT

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Written by Terri Belkas, Currency Analyst

Update: Forex market intervention remains a hot issue this week, as the risk of physical intervention by the Bank of Japan has jumped significantly while European Central Bank President Jean-Claude Trichet engaged in some jaw-boning of the euro.

Japanese yen – The risk of physical intervention by the Bank of Japan has increased significantly as the latest Commitment of Traders report shows that positioning is growing extreme. Indeed, speculative long positions on yen futures are at their highest level since February 2004, a month before the BoJ last intervened. As a result, traders should beware of holding on to USDJPY short positions and maintain tight stops, as a sharp turn higher could occur at any time.

Euro – The euro pulled back on Monday morning as ECB Jean-Claude Trichet noted that the Bank is "concerned about excessive exchange-rate moves" while he sees an "ongoing, very significant market correction." The rhetoric comes on the tails of a massive euro rally that propelled the currency to record highs of 1.5459 on Friday. As we mention below, verbal intervention by European officials is relatively common, and the impact of Trichet's comments may be limited as he stopped short of calling the moves "brutal."


Originally published March 7, 2008:

The broad weakness of the US dollar has hit the forex markets hard recently. Indeed, over the past few weeks, the currency has plummeted amidst dovish rhetoric from Fed Chairman Ben Bernanke and signs that the US is already in a recession. The flip side of the trade is just as important: the Euro is hitting new highs almost daily, the Japanese yen is nearing 9-year highs, and the New Zealand dollar has broken to 26-year highs. The rapid appreciation of these currencies could prove especially worrying for government and central bank officials, as the Euro-zone, Japan, and New Zealand all depend on exports for economic growth, especially as consumers tighten their purse strings and spending fades. As a result, it is worth questioning if the European Central Bank, the Bank of Japan, and the Reserve Bank of Zealand will make a coordinated effort to stave off an all-out crash of the US dollar in an attempt to weigh down their own currencies.

These Banks are no strangers to intervening in the currency markets. The last time a major coordinated effort was made to intervene was in September 2000, when the Fed, BOE, BoJ, and BoC joined forces with the ECB to support a beleaguered euro. Meanwhile, the RBNZ intervened just last year to cap gains in the New Zealand dollar. Will we see a repeat in 2008?

Bank of Japan – Most Likely to Intervene Independently

Of the G-10 countries, Japanese policymakers are the most likely to get their hands dirty and intervene in the currency markets when the Japanese yen’s price movements are too volatile and extreme for their liking. However, the Bank of Japan and Ministry of Finance have been a bit more lenient in recent years, as the last official intervention was conducted in March 2004. Nevertheless, policymakers have plenty of reason to be concerned about the Japanese yen’s most recent surge, as the USDJPY pair has recently tumbled to am 8-year low of 101.40. The strength of the currency is hurting the profit margins of major Japanese corporations, as the most recent Tankan survey showed that most Japanese corporations forecast the value of USDJPY in 2008 to be around 113.00. With the pair now rapidly approaching the 100 level, those hedges are deep in the red. Furthermore, Japanese Economy Minister Hiroko Ota noted that the approximate break-even point for companies is at the 106.60 level, and firms like Toyota, Yamaha Motor Co., and Nippon Steel have all reported disappointing earnings as a result. Unsurprisingly, the shares of exporters have taken a hit and are a major reason why the Nikkei Stock Average has plummeted declined 6 percent over the past five days, the biggest loss since the week ended August 17.

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Given the virtual standstill in economic activity, the growing squeeze on Japan’s export sector, and the sharp drop in the Nikkei, it is not unreasonable to wonder if the Bank of Japan may consider intervening in the currency market to help prop up USD/JPY above the 100 level – a point not seen since December 1995 – in order to assure that the country’s exporters are not crippled by uncompetitive exchange rates.
While the effectiveness of currency intervention as a policy tool has been an ongoing debate within the financial markets and academia for years, there is little argument that at least in the short term, it can be brutally effective. Amongst the G-3 central banks, the Bank of Japan is by far the most active practitioner of this policy. Furthermore, the Bank of Japan prefers to optimize the effectiveness of its intervention by fading speculative extremes, meaning that the currency pair can rise by hundreds of points within minutes. However, the most recent COT data shows that yen positioning is not extreme quite yet, suggesting the currency may have more room to gain. Either way, FX traders who are short USD/JPY need to be increasingly careful and stringent with their stops as the currency approaches 100.

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European Central Bank – With Inflation Running Rampant, Intervention May Do More Harm Than Good

Although selling euros in the cash market would certainly create a near term correction in the EURUSD, it is unlikely to be a viable medium term solution. When the ECB intervened back in 2000, fundamentals supported a stronger EURUSD, as the pair traded near 0.86. While the intervention was initially a losing proposition (the pair fell to 0.8225 within a month), the move was eventually effective in creating a bottom in the currency pair. This time around, the US economy is markedly worse off than that of the Euro-zone, which does not necessarily warrant a weaker euro. Nevertheless, European officials – who frequently rely on verbal intervention attempts – have recently signaled discomfort with the euro’s ascent as companies that export heavily to the US are suffering. Euro Group Chairman Jean-Claude Juncker said just a few days ago that, “for the first time in our agreed terms of reference we (Euro-zone finance ministers and ECB President Trichet) say that in the present circumstances we are concerned about excessive exchange rate moves. We have never previously said that we were concerned on the basis of current circumstances. We don't think the recent moves are reflecting economic fundamentals.”

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The comments were followed up by a dour outlook by Martin Winterkorn, the chief executive of Volkswagen, who said that the company will likely continue to lose money in the US, which is the world’s largest car market, despite numerous attempts to become more competitive. Mr. Winterkorn told the Financial Times, “At this dollar level, break-even would be difficult.” However, the rhetoric has done little to cool the euro rally, and to a certain degree, the currency’s gains could not have come at a better time.

Indeed, inflation in the Euro-zone is accelerating at a rapid 3.2 percent annualized pace, the fastest rate of growth since the euro was introduced in 1999. The combination of record energy and food prices has led broad consumer costs to rocket, but consider this: if the euro were to weaken, the cost of imported goods like oil would rise even faster. As a result, the Euro-zone is actually benefiting from the currency’s appreciation given the current inflationary environment. These circumstances underpin the ECB’s focus on price stability, as the Bank left rates steady at 4.00 percent in March and followed the decision up with hawkish commentary from ECB President Trichet.




Reserve Bank of New Zealand – After A Failed Attempt in June 2007, Will They Try Again?

During June 2007, just a week after raising interest rates to 8 percent, the Reserve Bank of New Zealand did the unexpected; they attempted to artificially weaken the New Zealand dollar by selling it outright in the foreign exchange market for the first time since the currency was floated back in 1985. Not only was the impact of intervention completely inconsistent with the impact of an interest rate hike, but the action didn’t work. Indeed, at that point, the New Zealand dollar had increased 26 percent against the US dollar to a high of 0.7637. While the currency initially backed down, it ultimately rallied as high as 0.8107 before posting a more substantial decline. While the RBNZ did not specifically say that they intervened at this point, a net selling of nearly NZ$1.5 billion by the central bank occurred during the month, suggesting they had something to do with the initial decline.

As an export dependent country, the general fear is that the strength of the kiwi would take a big bite out of exports. Both RBNZ Governor Bollard and Finance Minister Cullen had repeatedly warned that the currency is extremely overvalued.  Yet despite this strength, the RBNZ had no choice but to raise interest rates four times over the course of 2007 to a current record high of 8.25 percent as inflation growth spiraled out of control. The unprecedented move indicates that this was a very serious step for the central bank and not one that to been taken lightly. However, the RBNZ has not intervened since mid-2007, despite the New Zealand dollar’s climb to a fresh 26-year high of 0.8213. Similar to the Euro-zone, the New Zealand economy is benefiting from the inflation-fighting abilities of a strong kiwi, as the appreciation helps to quell import price growth. Furthermore, when Trichet last used the words “brutal” to describe the currency’s move in 2004, the EUR/USD rallied 13 percent in 2 months. Since the beginning of this year, the EUR/USD is only up 6 percent which explains why the central bank is not stressed about the latest moves. However, if the euro ascent is still taking place when inflationary pressures start to ease, the ECB will likely shift to a more dovish stance and consider cutting rates rather quickly, which would subsequently send the currency plummeting without having to utilize foreign currency reserves and physically intervening in the markets.

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Is Intervention Worth the Effort?

As we noted above, the Bank of Japan, European Central Bank, and the Reserve Bank of New Zealand have all engaged in FX intervention with varying degrees of success in the past. With over $1 trillion in official foreign reserves, the BoJ is by far the best equipped to attempt to put a cap on Japanese yen gains as the appreciation seriously impairs the profit margins of Japanese firms. The ECB and the RBNZ, on the other hand, have something to gain from their currency’s appreciation, despite the negative impact it has on exports, as it shields their economies from more severe import price inflation. As a result, the noted central banks may not find it to be in their best interest to make a coordinated effort to fight the market’s clear US dollar bearish tone and intervene physically in the cash markets quite yet.





Written by Terri Belkas, Currency Analyst, Forex Capital Markets LLC, DailyFX.com

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