300 Billion In Intervention Down, 35 Trillion (And 128 Days) To Go

From Goldman's Fiona Lake

1. Intervention in USD/JPY

As USD/JPY slipped below 83, in early Asian trading, the Japanese government stepped in to weaken the Yen for the first time since March 2004. This follows increasing verbal intervention and ‘threatening’ rhetoric in recent days.

With the re-election of Kan as DPJ leader yesterday, the timing is potentially a surprise given that intervention was perceived as more likely if Ozawa had taken the reigns. But this perception  may have been precisely why the authorities felt they needed to intervene, to stem the risk of speculative positioning becoming increasingly on-sided following the election outcome. The FX volatility around the outcome of the DPJ leadership election yesterday already had this flavour.

In addition to the DPJ election, the fact that the market started focusing on potential QE2 from the Fed last night added to the pressure via interest rate differentials.

Intervention to combat Yen strength was pretty quickly confirmed by FinMin Noda, who said it could hurt the Japanese economy and financial stability. Interestingly Noda wouldn’t comment on whether intervention was in USD/JPY, however the price action suggests this was likely to be the case.  Noda also commented that the intervention was taken alone and bold action would be taken when needed.  Commentary from a MoF official stated that intervention is not finished, which is not particularly surprising.

In the last phase of Japanese intervention running from early 2003 to March 16th 2004, the Japanese intervened on 129 of those days, accumulating Yen36.3trn-worth of reserves in the process. The most persistent phase of intervention was in late 2003, beginning of 2004 and the largest one day Yen selling January 9th 2004 of JPY1.6trn.  Over that period, the Japanese initially defended the 116 area, before stepping away in late September, in the run-up to the Dubai G7 meeting and ‘smoothing’ the cross down to 105-106. This level was subsequently defended heavily. The BoJ/MoF will provide aggregate data on the size of today’s intervention and any subsequent intervention on the last business day on the month. Detailed daily intervention data typically becomes available on a quarterly basis.

On the assumption that the volatility around the DPJ election result yesterday was a key trigger for intervention today, it is quite possible that the Japanese authorities will intervene again in response to similar circumstances and it is indeed possible that we see more intervention in the next few days. Broadly speaking, the administration likely want to introduce more two-way risk in USD/JPY in order to stem further speculatively Yen appreciation vs the USD or on a TWI basis. Despite intervention today, we would not rule out notable new lows in $/JPY at this stage. Importantly, the political environment is unlikely to tolerate persistent Japanese intervention given the broader political pressures to allow Asian FX appreciation.
BoJ Governor Shirakawa commented that he hopes MoF action will stabilise FX rates and that the BoJ will continue to supply ample liquidity to the markets and pursue strong monetary easing. This suggests that the BoJ are not in a rush to mop up the liquidity provided by today’s intervention. As a reminder, in an emergency meeting on August 30th the BoJ announced it would start providing 6-month term funding of approximately JPY10trn.
Japanese intervention stands in the middle of other macro events that have the potential to push $/JPY around.  We have long highlighted that USD/JPY has a close relationship with 2-yr swap differentials.  Admittedly, this relationship has ‘broken down’ since the beginning of August, possibly due to fiscal half-yearend repatriation flows by Japanese exporters.  However, interest rates will likely still matter.  We expect the Fed to undertake QE2 most likely at the November meeting and this has the potential to cause US fixed income to rally. Indeed, QE2 caught the market’s attention in New York trading yesterday despite better than expected US retail sales data and that caused US yields to fall (which also pushed the Dollar lower). A rally in US rates is likely to weaken the Dollar and by implication put renewed appreciation pressure on the Yen.  Given that both the US and Japan are going down the path of unconventional monetary easing, the most credible central bank is likely to ‘win’ the weaker currency.

Today’s Yen intervention has occurred against the backdrop of political disapproval of intervention to manage currencies.  Indeed, we think that the recent notable shifts in the CNY fix reflect political pressure on the Chinese administration to allow a stronger CNY.  We also believe this pressure is not just focused on the Chinese, but also on other administrations in the region which have been intervening heavily and indeed we have a trade recommendation to be short INR/KRW to capture this theme.  With intervention by the Japanese, which occurred after the PBOC fix today, it will be extremely interesting to see how the Chinese react in tomorrow’s fix.  The Japanese moves may also strengthen the resolve of the likes of KRW to smooth heavily even in the face of political pressure. Given the G20 have expressed disapproval of intervention to manipulate FX markets so commentary on intervention from this body will be interesting to watch.  As it stands, we think that the Japanese intervention will not be endorsed and pressure on the rest of the region to curtail intervention will remain.

On the back of the sharp Yen weakness, the Nikkei jumped by 2.7%, which marks a notable outperformance of the rest of the region which is up about half a percent. 10-yr JGBs rallied by 9bps, presumably reflecting the injection of liquidity. Asian currencies all weakened in response with the most notable weakness in KRW, MYR, THB and SGD.  The major currencies are pretty much unmoved.

2. What else is going on?

While today’s markets will remain focused on $/JPY, there are other items on the agenda.  On the data front, US releases are probably key and bring industrial production, where we expect an above consensus 0.3%mom rise, and MBA mortgage applications.  We also get the US Empire survey which will provide the latest snippet on business sentiment in the US.  The consensus is looking for a small rise from 7.1 to 8.0.  That said, in NY trading yesterday, the market started to latch on to the prospect of QE2 and thus ignored the better than expected retail sales data.  In our view, QE2 is most likely to occur later this year or early next, with the November meeting as our base case.

Ahead of the US data, the UK will publish the next batch of labour market data.  In Asian time, continued weakness in NZ credit card spending re-highlighted the weakness of the consumer and we expect the RBNZ to keep rates on hold at their coming meetings and to issue a rather cautious statement.  In Australia, consumer confidence weakened somewhat on the month, but remains at relatively elevated levels.  Despite the decline in consumer confidence and the overnight move in US rates, 5-yr Aussie swap rates climbed higher to 5.38% to the benefit of our paying recommendation.  We are raising stops from 4.80% to 5.20%.