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The Bank of Japan vs. The Market

Like the rest of Japan, The Bank of Japan was busy last night.  First, the BOJ announced they will be underwriting ten trillion yen in earthquake relief bonds.  They subsequently entered into an agreement with the G7 to intervene in the currency markets in order to weaken the yen. These moves have had the intended consequence.  The yen has crashed 3% against the dollar, and at the time of this writing, sits at 81.30.  The NIKKEI has surged, as well as U.S. futures.

This follows yesterday’s market action where the yen climbed to all-time highs against the dollar.  As has been reported, that move was partially precipitated by certain trading desks prevented from providing liquidity for the Yen.  I thought yesterday's climb might be the peak. It shaped up like the exhaustion gap that often indicates the top (or bottom) before an asset class retreats in the other direction, setting a new trend lasting years.  The two graphs below tell the story.  The first one is a twelve-month snapshot showing continued strengthening of the Yen.  Between October of last year and yesterday, the market had consolidated before the massive spike down.

 

USD-JPY1

The next graph shows the spike, followed by the Bank of Japan intervention which sent the yen crashing.

 

USD-JPY2

It would appear that the top is in for the yen, but there is no guarantee.  I would wager that we've seen the top, but either way, in either direction, this is a slow motion train wreck.  If the yen moves higher again and breaks 80, it will illustrate that there is massive disruption in the market.  This would call into question the practices of the Central Bank of Japan.  Also, it would likely point to the fact that the yen carry trade is coming unwound as investors repurchase yen to reverse their carry position. However, if it is the low and the yen begins deteriorating, yields on Japanese government bonds will start widening, the risk implied by credit default swaps will start surging, followed by a hyperinflationary bust for Japan.

There are myriad unknowns in the market right now and, what is worse, there are many unknown unknowns and lurking outliers.  The short term forces are extremely strong.  With the yen, you have two sumo wrestlers squaring off: The Bank of Japan and the market, which has a desperate short term need for yen as reparations and for exiting carry trade positions. It is hard to handicap men in thongs. Longer term, the Yen has probably reached - or will shortly reach - its apex.