In late trading on Wednesday, the yen went through the magical 80 yen/dollar barrier (125 in the reciprocal dollar/yen notation), and it did so with some verve. Rumors had been circulating previously that numerous stops and a bevy of options were tied to the 80 level, and it showed when the 80 level was taken out: Within minutes, the yen was trading in the 76 region, an enormous move for such a brief period. Below is a chart isolating the move on Wednesday night; not shown is the fact that after knocking out the stops and written options, the yen immediately pulled back again to the 79 level, its previous high reached in 1995.
[Click all to enlarge]
The yen-dollar rate goes medieval on option sellers and yen shorts on Wednesday evening.
A daily reciprocal dollar-yen chart shows the enormous move in all its glory – when the old high fell, the yen shorts scrambled to cover.
The yen weekly chart over the past three years. This is evidently a classical bull market. No market technician would short such a chart; nonetheless, shorting the yen has been a major pastime of all sorts of traders over the past few years.
The market's recent yen for the yen has now finally jolted the interventionist brigade into action. Yesterday the G7 issued a communique on the yen, promising "concerted intervention" to bring it down. Once again, a big move occurred in thin overnight trading – this time in the other direction.
Last night, the yen got the message that the G7 was going to gang up on it, and the yen-dollar went back above the magical 80 level.
The G-7 said in its statement that “in response to recent movements in the exchange rate of the yen associated with the tragic events in Japan, and at the request of the Japanese authorities” it will intervene in the currency market today. “We will monitor exchange markets closely and will cooperate as appropriate,” the statement said.
Against the dollar, the yen fell 3.2 percent to 81.48 at 10:48 a.m. in London, compared with the postwar high of 76.25 reached yesterday. It slid 3.7 percent versus the euro to 114.91. The Nikkei 225 (NKY) rose 2.7 percent at the close.
Japan’s intervention today was its first since September, when it acted on its own after the yen had climbed to 82.88, the strongest at that time since 1995. The Bank of Japan sold 2 trillion yen in that effort, which was the first such move since 2004.
“We won’t manipulate it, but I hope that the yen goes back to where it was before the earthquake,” Vice Finance Minister Fumihiko Igarashi said in an interview today in Tokyo. He added that the government at the same time wants to avert any “abrupt weakening” in the currency. Because the aftermath of the earthquake has “hurt the economy and fiscal situation, it won’t be a surprise” if bond yields go up and the yen weakens. “That’s naturally the biggest fear for the government.”
The European Central Bank, Bank of England, Bank of France, Germany’s Bundesbank and the Italian central bank all said they’re participating in the yen sales today. The central bank of China, which isn’t a G-7 member and belongs to the larger Group of 20, didn’t respond to a request for comment on yen sales.
What an odd thing to say: Just after it manipulated the yen, it states that it doesn't want to manipulate it? However, the Japanese government's fears regarding the currency and bond markets are perhaps not entirely unfounded; the bond market, especially, must worry it greatly. Although so far the JGB market has remained very strong, credit default swap spreads on JGBs have seen a huge spike higher – and that is often a precursor to bond market weakness.
No doubt the intervention was motivated by the fact that (as rumor has it) the Japanese banks specifically would be hurting if the 80 level were to be taken out decisively. Apparently they are the big options writers. We want to stress that we can not independently confirm this fact, but it does have the ring of credibility. Japan's banks are in all likelihood the biggest players in the yen and the derivatives tied to it.
The move in the yen was precipitated by a huge overnight jump in Yen-LIBOR rates on Tuesday, which rose in response to fears over rising counter-party risk.
According to Reuters:
Benchmark Japanese yen interbank rates jumped by the most in a day on Tuesday, reflecting rising counterparty risks as a deepening nuclear crisis in quake-hit Japan fueled risk aversion globally.
Some analysts said they expected yen interbank rates to grind higher but at a slower pace after the Bank of Japan offered to pump 5 trillion yen ($61 billion) into the banking system on Tuesday. This followed a record injection of 15 trillion yen in same-day market operations and eased monetary policy further to support the economy recover from a triple blow of a massive earthquake, tsunami and nuclear emergency.
While euro-yen futures edged higher after the BoJ moves, three-month yen Libor fixed up at 0.20000 percent from 0.19250 percent, its highest since mid-October.
"As the power situation deteriorated today, and stock markets tumbled, it should not be surprising that this is reflected in (yen) Libor rates as risk will have risen and counterparty risk will have increased as losses look to be rising," said David Rea, an economist at Capital Economics.
"The greater the risk, and the greater the perceived loss to the economy and by extension the financial system, the greater the pressure on Libor. The Bank of Japan can, and undoubtedly will, do what it can to ensure there is liquidity, but this will not remove risk.
The surge in overnight yen LIBOR on Tuesday: It has since then pulled back to 0.17375, which is still elevated but shows that the panic is receding for now – click for higher resolution.
The Dismal Record of Interventions
We would note to the G7 communique that it may be an indication that the yen's trend was ready to reverse anyway. By the time a currency move becomes so intense that the bureaucrats spring jointly into action, it often means that the trend was ready to reverse anyway. See the Plaza and Louvre accords on the U.S. dollar, where joint intervention was decided upon to first stem a strong rise and then a strong fall in the dollar. By the time the Plaza accord was decided upon, the dollar had become so overbought and overvalued that it would have fallen anyway. The illusion that the intervention caused it to change its trend of course survives to this day.
In the case of the yen, the proposition that joint intervention can change its trend is even more preposterous. The dollar is used as the world's reserve currency, so every central bank actually has a sizable hoard of dollars it can sell. This is not the case with the yen – only the BoJ can be reasonably expected to sell yen in volumes that could make a difference, and the BoJ's historical record in yen intervention is a long litany of dismal failures.
The idea that governments are able to influence long-term trends in financial markets is complete hokum, to put it bluntly. In fact, it is precisely the BoJ's dismal record that stands as incontrovertible proof of this contention, closely followed by the SNB's abysmal failure to stem a rise in the Swiss franc against the euro last year.
If a central bank is unable to stem an increase in the value of the currency which it can theoretically issue in unlimited amounts, only one conclusion can be arrived at: the market is bigger than any government or congregation of governments.
If the yen's trend now changes, it won't be because the G7 want it to. It will happen because the market deems the yen to be overvalued. If the yen's bull market has further to go – an outcome that is actually strongly suggested by its chart – then no amount of intervention will be able to stop it from doing so.
Japan's Money Supply Growth: The True Driver of the Yen's Exchange Rate
Let us also remember that Japan's money supply growth has been far lower than money supply growth in both the U.S. and the euro area for many years. There has therefore been a strong fundamental underpinning to the yen's strength, further exacerbated by Japan's perennial trade surplus. Year-on-year growth of Japan's money TMS as of February stood at 3.3%, which is actually a recent high point in this growth rate.
Why is money supply growth so slow in Japan? There are two major reasons for this.
One is the fact that Japan's private sector remains in de-leveraging mode in Japan's post-bubble era. Both corporations and individuals are still unwilling to add leverage to their balance sheets after the enormous shock of the post-bubble credit collapse. At one point in the mid- to late-1990s, Japanese bank credit growth was negative for 60 consecutive months.
The other reason is that the BoJ has been made independent – and the technocrats at the helm of the central bank are apparently very conservative and don't believe that much can be achieved by heavy monetary pumping. Not only did such attempts previously fail (Japan had two major iterations of "quantitative easing," and is currently engaged in a more modest third one), but there are also other considerations playing a role.
For one thing, the Japanese government has been in a non-stop Keynesian deficit spending spree over the last two decades. It has been following the advice of a number of U.S. economists, who urged Japan's government to boost aggregate demand by spending its head off.
Naturally, this has had the exact opposite effect of that predicted by said economists – instead of boosting the economy, it has prolonged the slump. The Keynesians now maintain that Japan did not spend enough or stopped spending at inopportune moments and similar excuses, but the fact remains that Japan has followed their advice and has nothing to show for it except a huge mountain of government debt, amounting to over 200% of the country's GDP.
Due to being saddled with such an enormous debt load, the government can simply not afford to pay a high interest rate on its debt. Were the BoJ to pursue a highly inflationary policy, interest rates would likely rise sharply from their current extremely low levels, which in turn would render the government insolvent in short order. All that deficit spending has put the BoJ into a box. It forces it to pursue a relatively tight monetary policy – which is actually a positive counterweight to the government's useless, never-ending spending sprees.
Japan's soaring government debt since the beginning of the economic slump in 1990. Prominent Keynesians such as Joseph Stiglitz, Paul Krugman or Nomura's Richard Koo tend to claim that Japan did not spend enough to rescue its economy from stagnation. If the above is these peoples' idea of not enough spending, we'd hate to see what they would consider a sufficient level of deficit spending. Of course, deficit spending can only delay economic recovery. Economic actors in the private sector are after all footing the entire bill; the government does not possess a secret stash of resources it can marshal. The more the government spends, the less the private sector will spend and invest.
Another important factor in the BoJ's relatively conservative policy stance is what we would term its institutional memory. The main monetary event of the past century that informs the thinking at the central bank is Japan's experience with hyperinflation immediately following World War II. Just as the brief but severe money supply deflation at the onset of the Great Depression is the overarching institutional memory that informs the Bernanke Fed, so does the Japanese hyperinflation of the post-war years influence the stance of the bureaucrats at the helm of the BoJ.
Data on Japan's true money supply , via Michael Pollaro. As can be seen here, Japan's money supply growth has been very tame, in spite of the near zero administered interest rate policy of the BoJ. The reason is that private sector credit growth remains extremely subdued in Japan's post-bubble era, and unless the BoJ goes on a major debt monetization spree, money supply growth will therefore remain very slow.
In the wake of the earthquake and the nuclear accident at the Fukushima Daiichi plant, it is of course possible that the BoJ's policy will undergo a dramatic change. It has already injected vast sums into the banking system to bolster liquidity and ensure the smooth working of the payments system. It has also reportedly bought up large amounts of REIT shares and other securities in recent days to arrest the slump in Japan's stock market.
Should the markets begin to suspect that this change in the BoJ's policy is not merely a temporary measure to stem the panic following the earthquake tragedy, but a more long-lasting shift in its approach to monetary pumping, the yen would surely begin to weaken of its own accord.
It remains to be seen whether this is actually going to happen – after all, Japan's government debt is now set to explode further, as the government has already announced it will engage in increased spending to help finance the clean-up and reconstruction.
Therefore, the government is still faced with the problem that it can not possibly afford to pay higher interest rates on its debt – which a change in the BoJ's policy stance would no doubt bring about.
