Japan Intervenes: BoJ Puts Cat Among the Pigeons

Highlights

The US dollar is firmer against the major foreign currencies, but the main interest today is on the first Japanese intervention in six years that has succeeded in driving the greenback through the JPY85.00. This appears to have weighed on the Swiss franc as well, which also is among the weakest performers today. For its part, the euro has been consolidating the Mon-Tues sharp gains. Initial support is seen near $1.2750, but look for North American to probe the offers that are thought to lie near $1.3050. Yen weakness has persisted through the European morning, even though the intervention appears to have ceased. The dollar rose to JPY85.54 before the momentum faltered. Additional resistance is seen near JPY85.75 and it seems likely that North American participants may try to test the resolve of Japanese officials.

The Japanese intervention has had a pronounced influence over equity prices in Asia. Most Asian stocks rose, including Japan’s benchmark Nikkei which increased 2.34% overnight. The rise in the Nikkei was led by industrials, consumer goods and, of course, exporters. In addition, in the MSCI Asia Pacific index almost three stocks advanced for each one that dropped. And yet European stocks retreated led by a 0.52% drop in the MSCI Euro index, as brokerage downgrades at Drax Group and Nokia offset the rally in Asia. On the whole, the overnight performance was led by Asian bourses as Japan, Australia and Singapore had the sharpest gains.

Japan’s 10 year bond rose the most in nearly two years on the speculation excess funds caused by the nation’s first currency intervention will flow into JGBS. The intervention was “unsterilized” which increases the money supply and is effectively a form of monetary easing. The yen intervention also led to a fall in German bonds, which curbed investors’ appetite for the euros safest assets before the German government sells 10 year securities. Moreover, Portugal’s borrowing cost increased at an auction of €750M of 12-month bills. The yields increased to 3.369 from 2.756 at a previous auction held on September 1. And finally, credit default swap investors are building positions on sovereign debt as European Union regulators resist calls by law makers to ban some trades, which would require traders to prove they can access underlying security to settle a naked trade.

Currency Markets

The main development has been Japanese intervention; the first such operation in six years. Although there has been much speculation of the likelihood of intervention, hinted at by stepped up verbal warnings by officials, but following the defeat of Ozawa in his leadership challenge, the immediate threat of intervention appeared to slacken and many market observers had pushed back the “expected” intervention until closer to JPY80 and maybe the start fo the new fiscal half year on Oct 1. In this sense the intervention caught the market wrong-footed.

The full details of the intervention are not known, but here is what the market suspects. In terms of size, the intervention is thought to have been around JPY100 bln (~$1.1 bln). It appears to have begun in the JPY83.25-60 range. This area may become more psychologically important, but some observers think that the JPY82 level is the “real” line in the sand. Also, there have been official suggestions that the intervention will not be sterilized. The 03-04 intervention was sterilized in the sense that the yen sold were raised not be simply printing money but by issuing finance bills. If the intervention is indeed not sterilized, then the yen sold will, at least on the margins, increase the supply of yen. Even though there are questions about the effectiveness of intervention in general, sterilized intervention is thought to have a lower probability of success than unsterilized intervention.

Another factor that would enhance the odds of successful intervention is if it was multilateral. It does not appear to be the case and therein may lie the rub. Intervention appears to be unilateral. That the US and Europe do not want to participate is not surprising, but under Japan could have sought to get other Asian-Pacific countries to participate, even if it meant providing them with the yen to sell. Reports suggest they may not have been contacted. The initial response by the European Commission seems surprisingly sympathetic. A Reuters report cited EC officials noting that exchange rates should reflect economic fundamentals. It also noted that despite Japan’s current account deficit too rapid of currency appreciation could threaten economic recovery. Japanese officials had previously suggested that it was harder to get an understanding with the US than Europe. The US reaction is awaited. In the current context, silence may be damning, but the lack of sympathy seems to be taken for granted. The surprise would be the other way, if the US showed support for the intervention.

Outside of Japan, news from the UK would be the other main development. First UK jobless claims unexpected rose last month, the first time since January. This comes on the heels of the recent PMI reports that all were weaker than expected and news of a deteriorating trade balance. Today’s jobs report underscore the soft patch the UK economy has hit. The consensus had called for a 3k decline but instead the unemployment claims rose 2.3k. MPC member Weale had just noted yesterday that the fiscal austerity, which will be further detailed next month, may undermine the labor market. In his speech to the unions, BOE’s King today kept the door open to additional QE if needed and defends fiscal tightening. Yesterday’s higher than expected inflation report seems to be the main obstacle to additional BOE measures.

It was not the BOE’s QE that was a market focus yesterday, but media coverage of a US investment house’s view that the Federal Reserve will engage in a new large scale (~$1 trillion) of US Treasuries. That said, the same economist does not expected a double dip, i.e., renewed contraction of the US economy which he assessed as a 1 in 3 chance. Yet Bernanke and some others Fed officials have placed the bar for new substantial purchases as a significant deterioration of the economy. The GDP forecasts do not seem to line up with that kind of action. Moreover, recall last week’s Wall Street Journal survey found some 60% of the economists survey expect a new round of asset purchases but the same percentage of respondents did not think it would be effective.

Upcoming Economic Releases

This morning at 8:30EST / 12:30GMT the US reports import prices for August. The consensus is for a small uptick to 0.3% from 0.2% in July. In addition, there is important manufacturing data released this morning. At 8:30 EST/ 12:30 GMT Empire Manufacturing is reported and the market is calling for a marginal increase to 8.0 from 7.10 in August. And finally, at 9:15 EST/ 13:15 GMT Industrial production and capacity utilization are both expected to increase.