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USDJPY: How Much Further Can it Fall Before Intervention?

Last updated 8/31/2010 5:18 PM ET (GMT -5) 10 Comments

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Kathy Lien

Director of Currency Research, GFT

THE STORIES IN THE CURRENCY MARKET

• USDJPY: HOW MUCH FURTHER CAN IT FALL?
• EURCHF HITS RECORD LOW
• GBP: SHRUGS OFF IMPROVEMENTS IN DATA
• CAD: WEAKER THAN EXPECTED GROWTH
• AUD: STRONG RISE IN RETAIL SALES POINTS TO HEALTHY GDP
• NZD: WEIGHED BY COLLAPSE OF SOUTH CANTEBURY FINANCE
• JPY: GOVT WANTS TO GIVE INVESTORS TIME TO ABSORB ANNOUNCEMENTS

EXPECTATIONS FOR UPCOMING FED MEETINGS

USDJPY: HOW MUCH FURTHER CAN IT FALL?

More than 3 weeks ago, we talked about how USD/JPY has a strong tendency to weaken in the month of August. In our special report that outlined the reasons why USD/JPY could break its 2009 lows (published on 8/09), we pointed out that since 1998 USD/JPY fell during August except for 2006 and 2009. The year 2010 was no different as USD/JPY ends the month down more than 3 percent. We had said that the “ reason why there is strong seasonality in favor of USD/JPY weakness this month is because of the reinvestment of bonus payments received on Toshin investments in July and the repatriation of Treasury coupon payments in mid August. Also, there tends to be more hedging by exporters ahead of Obon week, which is one of the most important holiday seasons in Japan .”  However this year in particular, there was one other factor pressuring the currency pair lower which was falling U.S. yields. The combination of demand for JPY due to reinvestment flows and the lack of appetite for U.S. dollars because of the weakening economic outlook pushed USD/JPY to a 15 year low of 83.58 last week and the currency pair now appears poised to test that level once again.

Inching Towards Intervention Danger Zone

Over the past 48 hours, USD/JPY has fallen rapidly despite the Japanese government’s decision to add 10 trillion Yen to their emergency loan facility. The government is now working overtime to put together a Y920bn stimulus package to support the economy. Yet it appears to be too little too late as investors continue to drive the Yen higher. We have longed believed that despite open criticism of the Yen’s strength and repeated warnings that Japanese officials are watching currencies closely, the central bank would not be inclined to resort to physical intervention. This was our argument throughout July and August when USD/JPY fell from 88 down to 83.58. However everyone has a bottom line or a point at which they will eventually cry uncle and we believe that for Japan, this level is around 80, right above the currency pair’s 15 year low. Never before had the Japanese government let USD/JPY fall below 79.75, which was not only the April 1995 low but also the record low. Once USD/JPY falls below 83, the risk of intervention will increase substantially and we will go from empty threats to a real battle against Yen strength. The latest CFTC data shows that long Yen positions are record highs, which is exactly what the BoJ likes to see before they intervene in the currency because it provides the best bang for the buck as the stopping out of these short positions will exacerbate the rally in USD/JPY. The price action in the forex market suggests that investors want to challenge the recent low in USD/JPY and we believe that this level will be broken. If that occurs, it would open the door for a move down to into the intervention danger zone between 82 and 79.75.

Fed Minutes and U.S. Economic Data Not Much Help

Today’s FOMC Minutes and U.S. economic data provided little help for the U.S. dollar. Any optimism that may have come from a better than expected consumer confidence survey or the rise in house prices was offset by the Fed minutes which confirm that the central bank is still thinking about easier monetary policy. According to the minutes, not only did the Fed consider reinvesting principal payments from agency debt and agency mortgage backed securities in longer term Treasuries (which they announced on August 10th) but they also considered reinvesting in mortgages. Although buying government debt was not discussed at the meeting, reinvesting into MBS could be seen as a precursor to that decision. The minutes also showed increasing division within the central bank as some members were worried that the recent decision would send the wrong signal to the market about the central bank’s willingness to resume asset purchases. Others called for an open dialogue on additional measures to ease policy should the outlook for the U.S. economy continue to weaken. Central bank officials were most concerned about the labor market and their expectation for a stronger recovery in 2011 was offset by their warning that the downside risks to the recovery have increased. Aside from the rise in the consumer confidence index, earlier this morning, we learned that house prices increased by 1 percent in June with year over year gains reaching 4.2 percent, which was slightly weaker than last month's 4.6 percent report. Manufacturing activity in the Chicago region continued to grow at a slower pace with the PMI report falling from 62.3 to 56.7, the weakest since November 2009. Except for supplier deliveries, all of the underlying components decreased with the most pronounced decline seen in new orders and production. The slowdown in manufacturing activity in the Chicago and Philadelphia regions point to a weaker manufacturing ISM number for Wednesday. The market will also start to turn its focus to Friday’s non-farm payrolls report with the Challenger and ADP reports due for release tomorrow.

EURCHF HITS RECORD LOW

The big story in Europe today was the sharp rally in the Swiss Franc. The Swissie rose to a fresh record high against the Euro and a more than 1 year against the British pound. Although the rally in the currency was partially triggered by stronger economic data, demand for a true safe haven remains the primary reason why investors are snapping up the Franc. Unlike the U.S. and Japan where central bankers are actively engaging in easier monetary policy, the Swiss National Bank is amongst the few that are considering tightening. Economic data has been relatively steady with the latest UBS Consumption Indicator climbing to the highest level in more than 2 years. This measure of consumer expectations is a vote of confidence for not only the Swiss economy but also Switzerland’s currency.  It is not hard to imagine why the Franc is in demand when business activity and consumer appetite has increased. Of course, the sharp gains in the currency raise the risk of intervention by the SNB, but we expect the central bank to resort to verbal intervention first. Meanwhile the euro ended the day virtually unchanged against the U.S. dollar following the German unemployment report which showed a continual improvement in the labor market. A total of 17k Germans fell off unemployment rolls in the month of August, keeping the unemployment rate steady at 7.6 percent. Although this figure was slightly worse than expected, the upward revision to the prior months report made the initial sell-off in the EUR/USD very short-lived. German retail sales are scheduled for release tomorrow and despite the improvement in consumer confidence, there is a good chance consumer spending may have decreased because the latest Retail PMI showed a steep fall in consumer demand. For the first time since May, retail PMI turned negative with the index slipping from 57.2 to 48.4. With the World Cup over and the weather far from helpful, consumers have cut back spending. The silver lining however is that retailers believe that sales will rebound next month. 

GBP: SHRUGS OFF IMPROVEMENTS IN DATA

The British pound fell steeply against the U.S. dollar despite relatively positive economic reports. Consumer confidence improved significantly in the month of August, a sign that the improving economy could boost consumption.  If you recall, last week’s GDP number showed relatively healthy growth in the second quarter.  Therefore it is not much of a surprise to see the Gfk Consumer Confidence survey rise from -22 to -18, which basically erases a similarly large decline the prior month. Mortgage approvals also increased from 48.6K to 48.7K while net consumer credit rose by 0.2B. Although some analysts have highlighted the sluggishness of these reports, we believe that an increase in mortgages is better than a decrease particularly since that was what the market had anticipated. There is still not much activity in real estate sector in the U.K., but any activity that we have seen has been more positive than negative. Today’s data also showed credit card lending rising the most since February. Manufacturing sector PMI is scheduled for release tomorrow and this report along with service sector PMI on Friday will provide a better look into the current state of the U.K. economy and whether the weakness in the currency is justified. The break of 1.54 in the GBP/USD puts the next support level below 1.52. 

CAD: WEAKER THAN EXPECTED GROWTH

The Canadian, Australian and New Zealand continued to weaken against the greenback but the degree of the losses reflect the relative economic health of the commodity producing countries. The Canadian dollar for example sold off the most on a pip basis after weaker than expected second quarter GDP figures. After growing by a downwardly revised 5.8 percent in the first quarter, the Canadian economy expanded by only 2.0 percent in the second quarter. As our colleague Boris Schlossberg said this morning, “Today’s news suggests that despite robust demand for its commodity products, Canadian economy may be experiencing the spillover effects from the slowdown in growth of the US economy as the whole North American block faces a difficult second half of the year. Today’s weaker than forecast GDP results are only the latest miss in a string of recent economic disappointments from Canada. The country reported weaker Retail and Wholesale sales as well as softer CPI data in the month of August.” On a percentage basis, the New Zealand dollar fell the most after news that South Canterbury Finance collapsed. The New Zealand based financial company filed for receivership last night, forcing the New Zealand government to pledge to repay all of the company’s 13,000 depositors. Like in other parts of the world, when a bank fails, taxpayers are left to foot the bill. The Australian dollar on the other hand ended the New York trading session only marginally lower against the greenback thanks to a series of stronger economic data. Retail sales and building approvals rose significantly in the month of July while the current account deficit shrank by more than 60 percent in the second quarter. These latest reports show that the Australian economy continues to run on all cylinders and we believe that this strength will be echoed in this evening’s second quarter GDP number. Aside from Q2 GDP, Australia also has manufacturing sector PMI on tap. 

JPY: GOVT WANTS TO GIVE INVESTORS TIME TO ABSORB ANNOUNCEMENTS

The Japanese Yen strengthened against every major currency except for the Franc as traders continue to challenge the resolve of the central bank. The latest comments out of Japan suggest that they may not be ready to resort to intervention, but will become increasingly willing to do so if USD/JPY continues to fall. Clearly the increase in monetary stimulus failed to stem the rise in the Yen and it is possible that the Japanese government may want to see how the market responds to their new fiscal stimulus plan before stepping in and selling Yen. Last night, the Minister for National Strategy said it is too early to determine how markets will evaluate the steps outlined by the central bank and government yesterday to counter the strong yen and improve the economy. Finance Minister Noda said the said the BoJ and government’s measures will start to take effect and showed its readiness to take “bold action on currencies” if needed. Fiscal stimulus would have probably been more effective if the announcement was a surprise, but all of this pregame talk has unfortunately undermined its potential impact on the currency market. Although vehicle production decreased in July, housing starts and small business confidence edged up slightly. No major economic reports are expected from Japan this evening. 

AUD/USD: Currency in Play for Next 24 Hours

The AUD/USD will be the currency pair in play tomorrow with Australian manufacturing sector PMI scheduled for release at 7:30pm ET (23:30 GMT) and Q2 GDP scheduled for release at 9:30pm ET (1:30 GMT). The U.S. will follow with the Challenger Job Cut report at 7:30am ET (11:30 GMT), the ADP Employment survey at 8:15am ET (12:15 GMT) and manufacturing ISM at 10:00am ET (14:00 GMT).

The AUD/USD is trading between its significant support and resistance levels and appears prime for a breakout. There is a relatively clear triangle consolidation in the currency pair.  Taking a step back, we can also see a relatively clear inverse head and shoulders formation which suggests that the break in the AUD/USD could be to the upside. If the AUD/USD breaks above 90 cents, there is no major resistance until the August high above 92 cents. On the other hand, if it breaks below 0.8860, there is no major support until the 50% Fibonacci retracement at 0.8725.

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Comments (10)

Lang

August 31, 2010 at 06:22 PM ET

Kathy, how would you compare Japan's economy when they last intervened and the current economy when they are thinking about intervening? Was the economy doing well then? Is the economy doing better now and so justifying a higher yen?

What is the possiblitiy that they wont intervene at all, to encourage its companies and high wealth individuals to seek investments elsewhere. Like the M&A or aquiring investment properties or equities in the US, Europe and China?

margaret

August 31, 2010 at 07:16 PM ET

A strong currency is good for the Japanese consumer, food, holidays all cheaper. Japan has alot manufacturing activity off shore so surely a stronger yen means higher returns flooding back into the country.

Hey Dragon and Neo - you are my fav posts but Dragon I'm curious, what makes you think there will be a big bear apart from the traditional September activity? I'm not suggesting your wrong at all but if you have a magic crystal ball then I have some questions for you.

FXDragon

September 01, 2010 at 01:21 AM ET

I just think the prices topped in most currencies, commodities and certainly in some emerging markets. While the dow looks ugly, some emerging markets indexes are at historic highs! Those countries have a lot less debt than developed countries and they yield a lot more int. rates. Anyhow they broke highs again and only major risk aversion corrects those markets because thats when funds exchange major dollars.
There may be little more fake rallies before the crash, but i'll be a seller until prices get a lot cheaper. We just have to be patient and see...
I've also been collecting s&p data since 1980 on monte carlo simulation, but that's more like a physics or math crystal ball.

FXDragon

September 01, 2010 at 01:33 AM ET

And when it happens, techs will say 'retracement fib levels' And fundmntlsts will say 'fears of world recovery' And magically they will all be right:)
I just love to predict before it happens instead of while or after.

hsbc

September 01, 2010 at 10:41 AM ET

we all know that you love to predict but we really wish you can be right, at least for once.

FXDragon

September 01, 2010 at 12:48 PM ET

Ok genius so are you a bull now? Euro 1.35? Im shorting to 1.18. It'll crash next week. What do you say?
Even Kathy and China cant save you. Think well.

Semaj

September 01, 2010 at 03:43 PM ET

If I can remember correctly hsbc called 1.25 to be hit first while fxdragon was buying up to 1.35 for the eur/usd when it was @ 1.30. Didn't hsbc win the commentary alpha dog status on that bet, at least close enough.

At the same time fxdragon was buying usd/jpy to 88 from 85. Now fxdragon is selling both? Things change in the market these days very quicly it seems and hindsight is still a perfect 20/20.

All this crap shooting/roulette wheeling is useless to the readers on this sight so please offer intelligence such as B&K or nothing at all.

Doobp

September 01, 2010 at 01:13 PM ET

hsbc and fxdragon never stop arguing. hai.

"Japan has alot manufacturing activity off shore so surely a stronger yen means higher returns flooding back into the country" quoting margaret, does anyone second that stronger yen will bring higher returns? wasnt leaders afraid that yen will hurt the economy?

it appears to me that japanese leaders are ready to fight a fire but will they be able to mend whatever the fire has caused? i meant, there are more long terms consequences to bear if they intervene too late.

schultzz.at

September 02, 2010 at 03:29 AM ET

Japanese automakers indeed assemble most vehicles sold in North America in U.S., Canadian or Mexican factories. See the following story:
http://www.bloomberg.com/news/2010-08-19/honda-founder-s-dream-of-u-s-production-protects-earnings-as-yen-surges.html

From an accounting perspective they are able to protect revenue, but they still have to repatriate profits from their affiliates to the Japanese parent. At this point they suffer from the strong yen.

The article estimates that Honda assembles 89 percent of its vehicles in North America, while the numbers for Toyota and Nissan are 68 percent. Operating profit is estimated to suffer 16 bill. ¥ at Honda and 30 bill. ¥ at Toyota for every 1¥ gain vs. the dollar. Current earning forecasts are based on 90 ¥.

I still think that the odds favor a rise in U.S. bond yields and the USD/JPY. Basically, because sentiment is leaning towards a double dip recession in the U.S. which is unlikely to happen in the near term. U.S. GDP suffered big time in Q2 from a surge in imports (this component subtracted -4.45 percentage points). This was most likely an anomaly and we may see some improvement in the trade figures for the current quarter.
Tom Schultz.

Doobp

September 01, 2010 at 01:26 PM ET

FXDragon: after saying so much, what are your reasons for shorting Eur? i didnt see any reason. beside, i dun see why does dow (US market) and emerging market need co-relations?

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About The Author

Kathy Lien began her FX trading career 10 years ago at J.P. Morgan Chase. After graduating New York University’s Leonard Stern School of Business at the age of 18, Kathy joined the bank's interbank FX trading desk and eventually moved to the cross markets proprietary trading desk. In the interbank market, her ability to create solid fundamental and technical analysis from the myriad of information on the market helped her trade forex spot and options. Her experience eventually led her to be chief strategist at Daily FX where she worked until she joined GFT in 2008.

With her knowledge of forex, as well as her experience trading other products, such as interest rate derivates, bonds, equities, and futures, Lien has built a reputation as an international currency analyst. She is frequently quoted on CNBC, Bloomberg, Fox Business and Reuters. Lien has also written for publications like Active Trader, Futures, and SFO magazine. She is the author of the newly updated Day Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Boris Schlossberg.

To buy Kathy’s newly updated Day Trading and Swing Trading the Currency Market: Technical and Fundamental Strategies to Profit from Market Moves, click here.