It seems, well, “appropriate” that to top off a (relatively) wild week for markets and central banks, the prospect of yen intervention dominated trading on Friday, following media reports that Japan’s prime minister and central bank head are set to meet next week to discuss ways of dealing with the currency’s strength.
The move was clearly another attempt at verbal or “indirect” intervention to curb the currency after the yen broke through Y85 to hit a 15-year high of Y84.72 against the dollar on Thursday.
Adding to the hype, minutes from the Bank of Japan’s July meeting, published on Friday, showed that BoJ board members last month signalled growing concern about the yen’s advance, suggesting they were increasingly seeing the impact of yen strength on Japan’s exporters as a bigger economic threat than fallout from Europe’s sovereign-debt crisis.
That revelation, as Bloomberg reported, prompted some analysts to predict possible intervention.
Yet, as the FT noted, Japan’s finance ministry has not intervened in the currency markets for six years. Between 2003 and 2004, it spent Y35,000bn in a bid to stem the rise of the currency but it still appreciated from Y117 to Y104.
And while some analysts are suggesting that Tokyo may be moving to a more active stance on the currency, many strategists still say direct intervention from the finance ministry is unlikely, given the relatively poor shape of the global economy since the last round of yen intervention. Also, the FT noted, as a G7 country, Japan is encouraging China to allow a more flexible renminbi.
In addition, it notes, the real effective exchange rate, which takes into account inflation, is not at extreme highs, unlike the nominal rate.
Indeed, The Oriental Economist’s Richard Katz noted on Thursday that while nominal yen is strengthening again, reaching its highest level since 1995, real (price-adjusted) yen remains at average post-1986 level.
Driving the yen’s rise, in his view, is the drop in US interest rates due to Fed monetary action as well as fears of a softening economy and possibly even a bout of deflation
According to CLSA strategist Christopher Wood, “there remains a growing risk that the yen appreciates further in the absence of any concerted effort by the Japanese authorities to push it down.”
In his latest Greed&Fear client newsletter, Wood says:
A further appreciation of the yen is clearly the last thing investors in Japanese stocks want to see. For they have become accustomed in the 20 years since the Bubble burst to the view that a weakening yen is the only plausible trigger for a decent stock market rally.
Operating margins of corporate Japan are now back to pre-crisis levels even though revenues are still about 15% lower. This is impressive even though in aggregate corporate cost cutting only compounds deflationary pressures. But it does mean that, 20 years on, the Japanese corporate sector is more adjusted to the reality of deflation than its American, British or indeed Spanish counterparts.
As Lex noted on Friday: the question is, what is Tokyo’s interpretation of “appropriate action”, following Japan’s finance minister Yoshihiko Noda pledge, in an unscheduled press conference on Thursday, to act appropriately against the strong yen.
Currency traders like to translate action as intervention; which is precisely what Noda hopes, notes Lex. The yen, having hit that 15-year high, obediently slipped back after his comments. But, in Lex’s view, intervention “will only be used in extremis”. The political costs are too high and the benefits less assured than in the mid-1990s, it adds.
Arguments against “in extremis” action include the following:
For one, the real effective exchange rate is well below the highs of that intervention-happy period (albeit similar to 2004, when the Ministry of Finance last went into the money markets). For another, Japanese manufacturers’ currency exposure is lower. Toyota Motor, for example, made more than three-quarters of its vehicles in Japan in 2003; this year local production will be less than half the total.
Nor, however, can the government afford inaction.
Export growth still correlates with the trade-weighted exchange rate and Japan’s business lobbyists are a noisy bunch, Lex says. Essentially, Japan’s problem is that it has lost its competitive disadvantage: a zero interest rate. Having virtually the lowest interest rate on the planet used to make the yen a natural choice for financing carry trades. Lex concludes:
Foreign investors borrowed yen by the truck-full, while Mrs Watanabe decanted her housekeeping allowance into Aussie dollars, rands or anything else offering a yield pick-up. That game lost momentum once the developed world joined Japan in pushing interest rates to near-zero: 3-month US and yen Libor rates crossed in 2009 and are now just a whisper apart.
Navel gazing – seeing which central bank inches ahead of the pack on any form of quantitative easing – does little to change perceptions on currency at this stage. Mr Noda’s position is a thankless one. When the world is falling apart, it really matters not a jot if your currency pays just a few basis points, your debt is twice economic output and you are onto your sixth prime minister in four years.
Related link:
BoJ governor on the yen – Money Supply
Renminbi-yen-dollar collision course - Tim Duy’s Fed watch
Tokyo’s FX traders keep calm and carry on – FT Alphaville
A yen for bonds in ‘upside down’ financial world – FT Alphaville