Observations On How Much Capacity For Intervention The BOJ Has, And Whether Intervention Will Be "Sterilized"
Today the US Treasury got a gift: a future guaranteed buyer of at least $300 billion more in bonds. But before we get there, the number one question in the minds of FX traders right now is just how much buffer does the BOJ have for current and future Yen selling, and just when will BOJ intervention end, as nobody wants to be selling the USDJPY/EURJPY only to be caught flatfooted as the Yen ramps another 100/200 pips lower. Goldman Chiwoong Lee provides the answer, which may not be the one those who are itching to go long the Yen again are looking to hear: essentially based on statutory limitations, the BOJ can implement as much as Y35 trillion of intervention capacity, which is roughly the same amount as used during the last intervention, when the Yen stayed relatively flat only to proceed its upward climb once again. Furthermore, the 35 number is a soft ceiling, and the Diet can easily raise it if seen as necessary, very much the same way the US can and will hike its debt ceiling in early 2011. And probably an even more important question to the US is whether or not the intervention will be sterlized (i.e. offset against Bill issuance), or unsterilized, resulting in a mismatch in funding and a jump in the current account. For the answer to this as well, read inside.
More from Lee:
How much can the MOF intervene? A budget rule sets the upper limit of FX-bill issuance. The current limit is Y145 trillion, while the current outstanding is Y110.2 trillion. The MOF could implement Y35 trillion of intervention now, which is almost equivalent to the total intervention conducted during the previous intervention episode of January 2003 – March 2004. That said, the government can submit a request to raise the FX bill limitation to the Diet, if necessary. This upper limit will be reviewed in the process of formulating the FY2011 budget (effective from April 2011) in any case.
On whether intervention will be sterilized or not:
The BOJ governor released a statement soon afterward, stating that the BOJ would pursue strong monetary easing, and continue to provide ample liquidity to the financial markets.
However, we do not interpret this as a direct statement of “unsterilized intervention”. In his book, Governor Shirakawa states that as long as the monetary authority sets a short term interest rate target, intervention in the forex market must be “sterilized”. Of course it is possible to change the interest rate target, but that would be a change of monetary policy itself. Today’s statement is not an announcement of monetary policy change.
Yen selling/foreign currency purchasing intervention is settled on the second business day after the intervention, and yen funds are paid to private financial institutions from the government. This factor causes the current account balance to increase (A). On the other hand, the government (Foreign Exchange Fund Special Account) raises yen funds needed for the settlement of intervention by issuing FBs in the market. Payments for FBs issued in the market are made to the government through current accounts at the BOJ. This factor causes the current account balance to decrease (B). Factors A and B offset each other, so the impact on the current account balance is neutral.
However, there may be a time lag between the settlement of intervention and the issuance of FBs in the market. In the bridging period pending the issuance of FBs, the BOJ may underwrite FBs, causing a short-term rise in the current account balance. However, after a certain period, as FBs are issued in the market, the current account balance will decrease. The Japanese intervention system is therefore essentially sterilized, with no change in the current account balance.
The BOJ announces the day-to-day current account balance and the factors affecting the balance. The fund surplus factor arising from fx intervention, however, is included as part of the “fiscal factor” of fund surplus/shortage, and is not identified independently. Fx transaction is settled two days after the intervention itself (T+2), but if there are other fiscal fund surplus factors on the same day, the additional fx fund factor will be just one part of the fund surplus factor. Vice versa, if there is a major fiscal fund shortage factor on the day of fx intervention settlement, the overall fiscal factor could be in “shortage”, despite the “surplus” factor arising from fx intervention. The BOJ looks at the overall funds surplus/shortage in the market of the day, and conducts liquidity supply/draining operation as necessary, in line with its overall monetary policy/liquidity supply stance at that time. Therefore, it is difficult to distinguish whether fx intervention is sterilized or not. The BOJ says this in its report “Money Market operations in Fiscal 2003”.
In addition, September is typically the month when the BOJ supplies ample liquidity, to ensure smooth settlement and keep money market pressure off in the run-up to the September 30th fiscal half-year end for corporate accounting. In both 2008 and 2009, the BOJ’s end-September current account balance increased by Y5 trillion or so compared to end-August. Today’s fx intervention “coincides” with the timing when the BOJ is “naturally” increasing liquidity supply. This makes the distinction of whether fx intervention was sterilized or not more difficult (and irrelevant).
All in all, the BOJ has clearly maintained its stance of supplying ample liquidity, but we do not interpret this as the BOJ’s announcement of unsterilized intervention. The important issue is the BOJ’s monetary policy/liquidity supply stance, which is eventually reflected in its current account balance. The BOJ is already obliged to gradually increase the current account balance in order to accommodate the six-month fixed rate operation which it announced at the August 30th unscheduled monetary policy meeting. The additional fund supply as a consequence of fx intervention will be treated as a part of the day-to-day overall fund demand/supply, and it may well end up in an increased current account balance (see Exhibit 1).
The expected slowdown in consumption as stimulus measures fade (end to auto subsidies, eco-points etc.) as well as downside risk in the global economy (pushing exports down) will keep the BOJ alerted to a downswing in Japanese economic growth. The BOJ has not decided on an unsterilized intervention today, but they may be pushed to implement further monetary easing (including unsterilized intervention) towards year-end as growth slows.
We think the BOJ’s policy tool options for additional easing would be, in order of likelihood, (1) expansion and/or extension of the three- and six-month fixed-rate fund supply operation, (2) expansion of lending targeted at strategic growth sectors, (3) expansion of liquidity supply including unsterilized intervention, (4) commitment to maintain the easy policy stance until a certain price level is reached, and finally, (5) increase in JGB outright purchase.
So net net, Japan issues debt, raises Yen, uses Yen to buy Dollars, uses Dollars to buy Treasuries, completing the ponzi loop whereby it has just added to its debt, using the proceeds to fund America's endless credit fueled spending spree. We would not be so sure that Schumer will want to get in the middle of this, as it will guarantee the US at least a few extra failure-free auctions. The simple reason: Japan just became a willing buyer of at least $300 billion more in future US auctions.