JPY intervention - Japanese regulators stemmed the losses, but for how long?

Japan’s Ministry of Finance and the Bank of Japan had been commenting on the volatility in the yen and warning against excessive price moves for months. Yesterday they finally did something about it and intervened in the currency markets for the first time since 1998!

Here’s what it looks like on the daily chart:

It’s more dramatic on the hourly view.

That single hourly candle traded a high of 145.839 and a low of 140.683: a 515 pip range! The intervention worked, sending a message to the market that this is no longer a one way trend.

There’s been some confusion about the intervention, coming as it did in the immediate aftermath of the Bank of Japan’s policy meeting. This isn’t a central bank decision. Whilst the central bank and Ministry of Finance are in close communication with each other, exchange rate policy is a government (MoF) decision.

Indeed, the central bank’s policy is part of the problem. The Bank of Japan is sticking with their low rate policy. Headline inflation is slightly above their 2% target, but core inflation remains low. The all-important wage growth (which the central bank says is key to sustaining inflation) just isn’t there yet.

So, the Bank of Japan’s low policy is more at odds than ever with the Federal Reserve’s hawkish rhetoric and aggressive rate hike cycle.

The timing of the intervention was likely pre-emptive. As interest rates rise in the US, the differential between US and Japanese bonds widens. The hawkish dot plot from the Federal Reserve’s projections had continued to pressure US bonds, sending US yields higher. This chart of USDJPY overlaid with the US/Japan 5 year yield spread shows the correlation:

Widening yield differentials after the two central bank meetings opened the door for a quick run on 150 in the USDJPY pair.

Markets had already been warned the week before when Japanese officials upped the ante pushing back against excessive yen weakness. A real masterclass in the art of the jawbone, including a ‘rate check’ (seen as the final step before actual intervention).The talk had sent USDJPY lower and left a double top in the 145 zone.

So, as the pair broke out above that double top just over a week later, the intervention put an end to things. For now at least.

The underlying pressures are still there however. The divergence in interest rates, economic strength and terms of trade all make it hard to get excited about a full trend reversal. ING’s Chris Turner thinks the battle could keep on running:

With the Fed turning ever more hawkish and the BoJ still printing money, it looks like the Japanese government wanted to stop a quick run to 150. Japanese authorities could well be doing battle with the FX market for the next 6-9 months as the dollar stays strong.

It’s hard to argue with that logic. Although a recession appears increasingly likely in the coming months, inflation is proving hard to shake. Worryingly, PMI’s from France & Germany today both included references to a renewed pick-up in inflationary pressures.

If persistent price pressures go global and finally break the Bank of Japan’s low interest rate resolve, it would be a historic moment in market folklore. It may become a necessary step to prevent a continued currency collapse if inflation persists.