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Bank of Japan, the yen and the increasing possibility of an intervention
Summary: More trouble may be brewing for the Japanese yen if the Fed stays hawkish this week. But a Bank of Japan pivot is still unlikely as wage inflation remains muted. The only other way for the Japanese authorities to defend the yen would be a direct intervention. However, a coordinated intervention remains unlikely and a unilateral intervention rarely has a long-lasting impact. We discuss how one could ride this in the direction of possible intervention, or on the reverse.
While the key focus is on the FOMC meeting this week, let’s not forget that we also have other global central banks racing to tighten policy to get the inflation runaway train under control. Still, the Bank of Japan continues to buck the global trend, remaining committed to its yield curve control policy and keeping the 10-year yields capped at 0.25%. This has meant a widening divergence to US yields, where the 10-year has reached 11-year highs at 3.50%. This has weighed on the Japanese yen, which is now close to its 24-year lows. A hawkish FOMC this week could further push up US yields, and in turn cause more pain for the yen.
The weakness in the yen is starting to hurt consumer and businesses, even as inflation in Japan remains very low compared to elsewhere. Japan’s August CPI touched the 3% mark, much higher than the BOJ’s 2% target. However, the Bank of Japan remains committed to achieving wage inflation, and is unlikely to remove accommodation just yet. The most hawkish signal we could get from the BOJ this week could be removing the dovish guidance. One of the key statements from their last meeting that we will be watching is:
“[The Bank] will not hesitate to take additional easing measures if necessary; it also expects short- and long-term policy interest rates to remain at their present or lower levels.”
But if we assume that the BOJ will not be ready to make any changes to their monetary policy stance or communication, there is further room for weakness in the yen. This is still possible, especially with the Fed nearing “peak hawkishness” and markets pricing in terminal rate close to 4.5%. Once the US yields peak and the US dollar tops out, pressure on the yen will ease. A sustained reversal in the Japanese yen will have to wait for a significant deterioration in the US economy, if Bank of Japan remains committed to its easy policy. But that’s unlikely to happen just yet, suggesting some more room for a weaker yen. And that will increase the possibility of intervention by the Japanese authorities.
With verbal intervention to defend the yen having minimal impact, the BOJ reportedly conducted a foreign exchange check last week. This move usually involves the central bank “inquiring about trends in the foreign exchange market” and is usually seen as a precursor for a formal intervention. While direct intervention is becoming more likely, it is unlikely to be effective if done unilaterally. Direct interventions are only effective if they are done as a coordinated effort with other countries. At this juncture, when all global central banks are fighting to bring inflation under control and protect their currencies from the wrath of the US dollar, it is unlikely they would agree to an intervention to support the yen, which would in turn weaken their own currencies.
That brings us two options to ride a unilateral intervention, if one was to happen:
- Ride the direction of the intervention, which would mean taking a position expecting the yen to strengthen. (See charts 1 and 2 below)
- Ride the reversal of the intervention, which would mean entering a position just after the intervention announcement (See chart 3 below). Usually, a large chunk of the move will happen in the first 30-60 minutes of the announcement, but the previous rounds of intervention from Japanese authorities were repeated in Tokyo, London and New York hours. If you expect the move to be somewhat reversed in the days/weeks that follow, you could position for yen weakness at that point.
In any case, it is worth highlighting that volatility is high and will likely pick up further if intervention happens. It might be a good idea to use stops on your positions, although liquidity conditions in fast markets do bring the risk of discontinuous pricing and slippage relative to stop levels.