The Yen’s Meteoric Rise: The Case for Intervention

Central Bank policy makers seemed to be engaged in a race to the bottom, each seeking to depress their currency in order to hike exports and increase the attractiveness of their labor force in the international market.

The Japanese have long advocated for a weaker Yen, particularly since China’s rise to prominence on the back of an artificially low Yuan, and have become alarmed at the rapid increase in their currency relative to major trading partners. Despite the fact that top policy makers expressed a commitment to open markets, the tide has rapidly turned and now these same individuals are openly speaking about market intervention. The probability of the BoJ taking steps to increase competitiveness via a Yen depreciation was greatly magnified by the recent announcement that China had surpassed Japan as the world’s second largest economy.  The case for intervention was put off by a fairly strong trade balance report, which showed Japan’s surplus growing by 120% in July, giving rise to the idea that a strong Yen may not be that detrimental to the economy. However, a closer look shows the surplus widening was driven primarily by a decrease in imports.

Japan is likely to take steps to regain supremacy in the near and long term. Efforts to stem the rise of the Yen should occur rather soon.

This bodes well for the U.S. dollar, which can be expected to be the primary target of BoJ purchases. Over the last decade, monthly purchases by Japan have been inversely related to dollar strength. Japanese demand for treasuries has risen over the last year; the country held 13.5% more in U.S. debt this June than it did a year earlier.

The last time Japan moved to manipulate the market price of the Yen was in 2004, implementing a massive program that will like serve as a benchmark for any action taken in the coming weeks. The 2004 intervention was called “awesome” by Alan Greenspan, who as shocked with the sheer size of the program. In just one day the central bank traded $20 billion against the Yen , helping to keep the Yen above the key psychological level of 105.

Although the currency drifted lower in the coming weeks, the intervention was viewed as a success domestically as it provided a momentum shift that helped the Yen drift lower for the remainder of the year. The spikes in the USD/JPY pair that the buying spurred helped Japanese companies and investors offload dollar holdings at favorable prices.

The real fear now, as it was in 2004, is thata rising Yen will impact the Nikkei adversely, pushing the market down and creating further impetus for the “safety” trade that has driven the Yen to its current level.  Japan’s export driven economy has struggled with deflation for two decades; some economists fear that the continuance of a strong Yen may be the tipping point for further economic malaise.

Many view past interventions as costly and ineffective, citing the depth of the currency market and the difficulties inherent with one participant attempting to swing cross rates. These critics also point to the relatively poor record of successful currency intervention in the past, with the Swiss National Bank earlier this year counting itself among the latest participants in this dangerous game of geopolitical economics.

In reality, open market currency intervention alone will fail to solve Japan’s myriad of problems. The underlying problems are deeper and range from a poor demographic profile to ineffective policy. However, if the Bank of Japan’s goal is to provide a temporary ceiling in the Yen and possibly reverse downward momentum in the dollar, they may be able to.

The bank next meets September 6th and 7th and one can expect more concrete action than the recent verbal interventions offered by the bank. One can also expect traders to anticipate this announcement and help rally the USD accordingly.

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