Reuters reported today that Japan is getting ready to intervene to weaken its currency. Japanese authorities are getting anxious because the yen is reaching the multi-decade highs versus the U.S. dollar last set in the wake of the Japan earthquake and tsunami in March. Those levels triggered a G7 coordinated intervention that substantially weakened the yen (see the New York Federal Reserve’s synopsis in “The Great Foreign Exchange Intervention of 2011“). It is not yet clear whether other countries will assist again. Enthusiasm for buying dollars and selling yen must be waning given the dollar’s persistent weakness and the yen’s stubborn strength. (The U.S. bought $1B worth of yen at the time).
Still, it seems Japan’s intervention is a matter of when not if. So it is easy enough to short yen and wait for the profits to roll in, right? Perhaps. The current trend is not Japan’s trend, and it is not the friend of anyone playing an intervention. Rumors preceded Japan’s unilateral intervention last September, but Japanese authorities moved after a two-day surge in the yen that brought it to what were roughly 15-year highs at that time. The intervention only provided one full day of relief for the yen. In other words, playing the intervention required position-sizing to sit through the losses on the way to profits that then had to be seized right away.
The chart below shows USD/JPY at that time (lower USD/JPY means higher yen versus the US dollar):
Source: dailyfx.com charts
Last year's intervention was only good for one day of relief for the yen.
Just as two heads should be better than one, a gang of countries should be more effective than one country. March’s G7 coordinated intervention not only quickly reversed an historic one-day gain for the yen, but also the momentum continued for almost a month before the primary trend reasserted itself.
Source: dailyfx.com charts
The coordinated intervention was temporarily more effective than last year's unilateral intervention. The end result was again failure.
So it seems there are at least two important elements to playing a potential yen intervention: 1) size the position to withstand a final surge to fresh highs for the yen (even better to have cash in reserve to sell into that surge); and 2) take profits quickly.
This time around, I have added a third idea. I am calling it “distributed positioning.” I have gone long USD/JPY and EUR/JPY to play weakness in the yen. While the U.S. dollar should be the primary beneficiary of an intervention, the euro could take over leadership in an intervention if the dollar moves quickly out of favor (relatively). I have gone short GBP/JPY to play any large surge in the yen ahead of the intervention (not to mention I am very bearish on the pound anyway). This position serves as somewhat of a hedge in case the yen is even stronger than expected ahead of an intervention. Finally, I am prepared to buy a large amount of AUD/JPY partially using (presumed) profits from the GBP/JPY position. The Australian dollar remains my favorite currency.
As for timing, I am assuming Japanese authorities will wait until the debt ceiling debate is resolved in the U.S. before they make a move. If the market interprets the outcome of the debt deal as “bad,” then the yen is sure to continue yet higher. Moving ahead of such a turn in events would severely hinder Japan’s latest efforts to stave off the enthusiasm of the yen’s tremendous fan club.
For an example of research on interventions see this working paper from the Federal Reserve Bank of Cleveland: “An Analysis of Japanese Foreign Exchange Interventions, 1991–2002.”
Be careful out there!
Disclosure: I am long FXA.
Additional disclosure: I am long USD/JPY, EUR/JPY; short GBP/JPY