Will Japan Intervene if the Yen Falls Below 100?

♠ Posted by Emmanuel in , at 3/11/2008 01:39:00 AM
Many doubted "Mr. Yen," Eisuke Sakakibara, when he said earlier this year that the Japanese currency unit would appreciate more quickly in lockstep with the Chinese yuan. The logic is simple: if the Chinese allow the yuan to revalue at a slightly faster clip, then Japan can allow its own currency to become stronger as well since competitive parity of exchange rates would more or less be maintained. This from Bloomberg:

The Chinese yuan may rise more than 10 percent this year against the dollar, allowing Japanese policy makers to accept further gains in the yen, said Eisuke Sakakibara, Japan's former top currency official.

China's currency has strengthened 1.4 percent this year, on course for the biggest monthly advance since the end of a dollar peg in July 2005, as the government seeks to curb inflation. The Group of Seven industrialized nations have called on China, Japan's biggest trading partner, to stop keeping the yuan artificially weak to support exports...

A rising yuan would make Chinese goods more expensive in global markets, bolstering the competitiveness of Japanese exporters. The yen may advance as much as 12 percent to 95 per dollar by summer as the U.S. economy slows and the Bank of Japan refrains from intervention to slow the rally, he said.

Sakakibara was dubbed "Mr. Yen'' because of his ability to influence the foreign-exchange market during his 1997-1999 tenure at the finance ministry. He correctly forecast in an interview in October that the dollar would plunge against the yen because of the risk of a U.S. slump.

Sakakibara-san also said there was pressure from the US against Bank of Japan intervention. Ah, good old-fashioned political economy:
Sakakibara said today that Japan's central bank is unlikely to intervene to slow the yen's advance because the U.S. government is opposed to interfering with currency markets.
Using a technical analysis, though, Daily FX says Bank of Japan intervention is possible if the yen breaks the JPY100 level. The chart above indicates the levels at which the Japanese came in to prop up the US dollar--at about JPY100. Of the major industrial economies, Japan is alleged to be the most likely to intervene. As always, FX traders will place their bets and see what happens:

Of the G-10 countries, Japanese policymakers are the most likely to get their hands dirty and intervene in the currency markets when the Japanese yen’s price movements are too volatile and extreme for their liking. However, the Bank of Japan and Ministry of Finance have been a bit more lenient in recent years, as the last official intervention was conducted in March 2004. Nevertheless, policymakers have plenty of reason to be concerned about the Japanese yen’s most recent surge, as the USDJPY pair has recently tumbled to am 8-year low of 101.40. The strength of the currency is hurting the profit margins of major Japanese corporations, as the most recent Tankan survey showed that most Japanese corporations forecast the value of USDJPY in 2008 to be around 113.00. With the pair now rapidly approaching the 100 level, those hedges are deep in the red. Furthermore, Japanese Economy Minister Hiroko Ota noted that the approximate break-even point for companies is at the 106.60 level, and firms like Toyota, Yamaha Motor Co., and Nippon Steel have all reported disappointing earnings as a result. Unsurprisingly, the shares of exporters have taken a hit and are a major reason why the Nikkei Stock Average has plummeted declined 6 percent over the past five days, the biggest loss since the week ended August 17.

Given the virtual standstill in economic activity, the growing squeeze on Japan’s export sector, and the sharp drop in the Nikkei, it is not unreasonable to wonder if the Bank of Japan may consider intervening in the currency market to help prop up USD/JPY above the 100 level – a point not seen since December 1995 – in order to assure that the country’s exporters are not crippled by uncompetitive exchange rates.

While the effectiveness of currency intervention as a policy tool has been an ongoing debate within the financial markets and academia for years, there is little argument that at least in the short term, it can be brutally effective. Amongst the G-3 central banks, the Bank of Japan is by far the most active practitioner of this policy. Furthermore, the Bank of Japan prefers to optimize the effectiveness of its intervention by fading speculative extremes, meaning that the currency pair can rise by hundreds of points within minutes. However, the most recent COT data shows that yen positioning is not extreme quite yet, suggesting the currency may have more room to gain. Either way, FX traders who are short USD/JPY need to be increasingly careful and stringent with their stops as the currency approaches 100.