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Why USD/JPY Peg is Unlikely and Fade vs Trade Intervention

Last updated 10/31/2011 10:12 AM ET (GMT -5) 1 Comments

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Kathy Lien

Director of Currency Research, GFT

Even though the media has been focused on the unresolved issues in Europe, the big story in the currency market this morning is Japanese intervention. For the third time this year, the Bank of Japan stepped into the market to sell Yen and buy U.S. dollars, triggering a move that took the pair from a record low of 75.575 to a high above 79 in a matter of minutes.  It also drove all of the Yen crosses higher, creating demand for euros and mitigating what could have been greater losses.  The problem for Europe is that China refuses to be their ultimate savior.  European officials have been courting Asian investors aggressively and with the upper hand, the Chinese will be asking for a number of sweeteners. 

Will Intervention Work?

As for USD/JPY, having pulled back 150 pips from its post intervention high this morning, the question now becomes whether this round of intervention by the BoJ will work.  It is no secret that unilateral intervention by a central bank is rarely effective and in the case of the Japanese, two out of the last 3 rounds of intervention lasted for no longer than 24 hours before the Yen began to rise again.  The only time intervention was effective was in March, when the G7 sold Yen in sympathy for the Japanese following the Earthquake.  This time around, there is very little reason for the G7 or G20 to back Japan's move.  Central banks around the world are looking to ease their own monetary policies and intervening in the Yen would be counterproductive. The only way intervention would work is if the Bank of Japan comes in repeatedly, spooking speculators from taking any short USD/JPY positions. Further intervention is certainly possible because the Japanese have a great deal of money to spend.  Back in September, the Japanese increased their war chest for intervention by Y15 trillion to Y46 trillion ($600B), the largest ever and the MoF vowed to do all that it takes to engineer a satisfactory movement in the Yen.  For intervention to be truly effective however, the U.S. needs to back off their plans to ease monetary policy because the main source of USD/JPY weakness has been the prospect of further stimulus from the Federal Reserve.  Unfortunately with manufacturing activity in the Chicago region slowing in the month of October, the chance of the Fed dropping their plans for QE3 remains slim. 

Why a USD/JPY Peg is Unlikely

In the meantime, the Japanese can take matters in their own hands by declaring definitively to the market that they will not allow USD/JPY to fall below a certain level, like the Swiss National Bank has done with EUR/CHF.  However this action by Japanese is unlikely because they do not have the same relationship with the U.S. as Switzerland does with the Eurozone. More specifically, China and not the U.S. is Japan's number one trading partner with Asia ex Japan representing 48 percent of all Japanese trade while U.S trade accounts for only 14 percent, just slightly above the country's total trade activity with Western Europe. For Switzerland on the other hand, 59 percent of all Swiss exports are destined for the EU and 75 percent of all imports come from the European Union.  This makes a USD/JPY peg far less effective than a EUR/CHF peg.

Although there is a VERY good chance that Japanese officials will intervene in the markets again, we are more inclined to fade than trade the move in USD/JPY.   

Source: Morgan Stanley

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Comments (1)

Darkdoji

October 31, 2011 at 02:05 PM ET

Makes sense! But fade sounds a shade dangerous to me. Of course it is a matter of skill, knowledge and experience. Personally, I will not even think about the Yen again. If you are correct, I will try to use this thinking elsewhere safer.

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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.