Friday September 17, 2010 - 15:44:37 GMT
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FX Briefing - BoJ climbs into the ring
FX Briefing 17 September 2010
ÔÉė Double-dip fears subside, euro firms above 1.30
ÔÉė BoJ intervenes to bolster the dollar after USD-JPY plunges below 83
ÔÉė SNB signals lower inflation risks, EUR-CHF soars
BoJ climbs into the ring
The slightly more positive assessment of the global economic outlook still prevails and is helping to strengthen the euro. The upbeat mood was reinforced by surprisingly strong Chinese industrial production and retail trade data released at the beginning of the week, but some US data ‚Äď in particular the surge in retail sales ‚Äď also painted a brighter picture. With regard to the FOMC meeting next Tuesday, the majority of market participants are apparently not expecting the Fed to announce any additional quantitative easing measures for the time being. The agreement on increased capital requirements for banks (Basel III) had a favourable impact on equity markets.
There were also remarkable signals from the SNB. In view of the appreciation of the franc and weaker global growth in the forthcoming quarters, the Swiss central bank predicts in its latest Monetary Policy Assessment that inflation will rise much more slowly than anticipated in June. The inflation forecast for 2011 was revised down from 1.0 to 0.7% and for 2012 from 2.2 to 1.2% (!). Thus the SNB is signalling that interest rate hikes are not on the cards at present. In our view, this signal is also meant to ‚Äúsoften up‚ÄĚ the franc somewhat. At any rate, EUR-CHF firmed significantly by three big figures to around 1.33.
The focus this week was on Japan, however. After prime minister Naoto Kans had won a leadership battle in his party (DPJ) on Tuesday, enabling him to remain prime minister, USD-JPY had continued to plummet initially. When it fell below 83, however, Japan‚Äôs tolerance finally snapped. For the first time since March 2004, the Bank of Japan intervened in the forex market. Massive yen sales catapulted USD-JPY to 84.50 early on Wednesday morning and up to around 85.5 later on in the day. Estimates based on BoJ money market data indicate that the BoJ could have sold around 1800bn yen ($21bn) ‚Äď the largest amount that the BoJ has ever sold in one day.
Since then, market participants have been wondering whether Japanese intervention will succeed in stabilising the exchange rate or whether the upward trend will continue to prevail. Going by previous intervention attempts, the chances of success are slim. From January 2003 to March 2004, the monetary authorities initially attempted to keep USD-JPY above 115, but then, after extensive dollar purchases, finally allowed the yen to appreciate to below 110 in September. A new line of defence was then set at 105, before the interventions finally ceased at the end of March. At that time, the appreciation pressure eased (for a time) when a rebound in private consumption in the US heralded the end of the low interest-rate phase. Three months later, in June 2004, the Fed raised interest rates for the first time.
One reason for scepticism is that the Japanese monetary authority‚Äôs intervention was one-sided, i.e. without the explicit support of the monetary authorities on the other side ‚Äď particularly the US. Comments made beforehand suggest that the Japanese finance ministry had attempted to come to an agreement with the US and the eurozone, but had met with little enthusiasm. The White House is counting on stronger exports compensating for weak domestic demand; moreover, the Treasury and the Congress are urging China to allow the yuan to more fully reflect a free-market valuation. Renewed forex market intervention in Japan does not really fit into the picture. Jean- Claude Juncker, chairman of the Eurogroup of eurozone finance ministers, actually called on Japan to stop the one-sided intervention.
As a rule, Japanese foreign exchange intervention is sterilised, i.e. the increased liquidity supply brought about by the yen sales is counterbalanced by other transactions. The BoJ intervenes on behalf of the finance ministry, but the sales are funded by so-called financing bills of the Foreign Exchange Fund Special Accounts, not by creating money. The central bank can, however, leave the liquidity in the market and put the financing bills on its own books. That seems to be the case at the moment: money market data are showing significant amounts of additional liquidity.
If the BoJ sticks to this principle, forex market intervention will be like additional quantitative easing, albeit not on the basis of domestic bonds or loans, but foreign currency assets. Non-sterilised intervention is generally considered to be more effective, because, as well as influencing the currency structure of private assets, it also has an impact on money market rates and liquidity supply in the markets. However, whether it can be effective when money market rates in all major industrialised countries are around zero as it is, is another matter.
Market participants‚Äô risk appetite has presumably waned as a result of the financial crisis, which could improve the chances of the exchange rate stabilisation succeeding. This assumption is underpinned by the sustained high implied volatility in the USD-JPY exchange rate, for example. Market participants are therefore less likely to speculate extensively against the central bank. It is striking that, in the intervention period from 2003 to 2004, the interventions had virtually no impact on high speculative long positions (CFTC Report IMM) from August 2003 to February 2004. It will be interesting to see how investors react to the monetary authority‚Äôs intervention in the current situation.
Some market observers think that the appreciation of the yen is being driven primarily by repatriation transactions and the Japanese export industry‚Äôs hedging transactions. If that were the case, it would be another point in favour of the yen stabilising: if the state hedges against currency losses, companies can scale down their own efforts.
Yet another argument is that the narrowing of yield spreads has more or less come to an end. On 2-year maturities, Japanese yields are around 0.13%; US yields are only a good 30 basis points higher at 0.47%. In previous years, USD-JPY has followed the spread movement (see chart 2). But if spreads can hardly become narrower (we are assuming that Japanese yields will not shoot up), the appreciation of the yen could come to a halt. First and foremost, however, we are expecting the slow recovery of the US economy to push up US interest rates sooner or later, which shouldstabilise USD-JPY.
Stephan Rieke +49 69 718-4114
+49 69 718-3642
Foreign Exchange Trading
+49 69 718-2175
Matthias Grabbe / Klaus N√§fken
+49 69 718-2146 / -2683
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