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Japan Intervenes To Weaken The Yen

Fuseworks Media
Fuseworks Media

Goldman Sachs Global Markets Daily: Intervention in USD/JPY

As USD/JPY slipped below 83, in early Asian trading, the Japanese government stepped in to weaken the Yen for the first time since March 2004. This follows increasing verbal intervention and 'threatening' rhetoric in recent days.

With the re-election of Kan as DPJ leader yesterday, the timing is potentially a surprise given that intervention was perceived as more likely if Ozawa had taken the reigns. But this perception may have been precisely why the authorities felt they needed to intervene, to stem the risk of speculative positioning becoming increasingly on-sided following the election outcome. The FX volatility around the outcome of the DPJ leadership election yesterday already had this flavour.

In addition to the DPJ election, the fact that the market started focusing on potential QE2 from the Fed last night added to the pressure via interest rate differentials.

Intervention to combat Yen strength was pretty quickly confirmed by FinMin Noda, who said it could hurt the Japanese economy and financial stability. Interestingly Noda wouldn't comment on whether intervention was in USD/JPY, however the price action suggests this was likely to be the case. Noda also commented that the intervention was taken alone and bold action would be taken when needed. Commentary from a MoF official stated that intervention is not finished, which is not particularly surprising.

In the last phase of Japanese intervention running from early 2003 to March 16th 2004, the Japanese intervened on 129 of those days, accumulating Yen36.3trn-worth of reserves in the process. The most persistent phase of intervention was in late 2003, beginning of 2004 and the largest one day Yen selling January 9th 2004 of JPY1.6trn. Over that period, the Japanese initially defended the 116 area, before stepping away in late September, in the run-up to the Dubai G7 meeting and 'smoothing' the cross down to 105-106. This level was subsequently defended heavily. The BoJ/MoF will provide aggregate data on the size of today's intervention and any subsequent intervention on the last business day on the month. Detailed daily intervention data typically becomes available on a quarterly basis.

On the assumption that the volatility around the DPJ election result yesterday was a key trigger for intervention today, it is quite possible that the Japanese authorities will intervene again in response to similar circumstances and it is indeed possible that we see more intervention in the next few days. Broadly speaking, the administration likely want to introduce more two-way risk in USD/JPY in order to stem further speculatively Yen appreciation vs the USD or on a TWI basis. Despite intervention today, we would not rule out notable new lows in $/JPY at this stage. Importantly, the political environment is unlikely to tolerate persistent Japanese intervention given the broader political pressures to allow Asian FX appreciation.

BoJ Governor Shirakawa commented that he hopes MoF action will stabilise FX rates and that the BoJ will continue to supply ample liquidity to the markets and pursue strong monetary easing. This suggests that the BoJ are not in a rush to mop up the liquidity provided by today's intervention. As a reminder, in an emergency meeting on August 30th the BoJ announced it would start providing 6-month term funding of approximately JPY10trn.

Japanese intervention stands in the middle of other macro events that have the potential to push $/JPY around. We have long highlighted that USD/JPY has a close relationship with 2-yr swap differentials. Admittedly, this relationship has 'broken down' since the beginning of August, possibly due to fiscal half-yearend repatriation flows by Japanese exporters. However, interest rates will likely still matter. We expect the Fed to undertake QE2 most likely at the November meeting and this has the potential to cause US fixed income to rally. Indeed, QE2 caught the market's attention in New York trading yesterday despite better than expected US retail sales data and that caused US yields to fall (which also pushed the Dollar lower). A rally in US rates is likely to weaken the Dollar and by implication put renewed appreciation pressure on the Yen. Given that both the US and Japan are going down the path of unconventional monetary easing, the most credible central bank is likely to 'win' the weaker currency.

Today's Yen intervention has occurred against the backdrop of political disapproval of intervention to manage currencies. Indeed, we think that the recent notable shifts in the CNY fix reflect political pressure on the Chinese administration to allow a stronger CNY. We also believe this pressure is not just focused on the Chinese, but also on other administrations in the region which have been intervening heavily and indeed we have a trade recommendation to be short INR/KRW to capture this theme. With intervention by the Japanese, which occurred after the PBOC fix today, it will be extremely interesting to see how the Chinese react in tomorrow's fix. The Japanese moves may also strengthen the resolve of the likes of KRW to smooth heavily even in the face of political pressure. Given the G20 have expressed disapproval of intervention to manipulate FX markets so commentary on intervention from this body will be interesting to watch. As it stands, we think that the Japanese intervention will not be endorsed and pressure on the rest of the region to curtail intervention will remain.

On the back of the sharp Yen weakness, the Nikkei jumped by 2.7%, which marks a notable outperformance of the rest of the region which is up about half a percent. 10-yr JGBs rallied by 9bps, presumably reflecting the injection of liquidity. Asian currencies all weakened in response with the most notable weakness in KRW, MYR, THB and SGD. The major currencies are pretty much unmoved.

2. What else is going on? While today's markets will remain focused on $/JPY, there are other items on the agenda. On the data front, US releases are probably key and bring industrial production, where we expect an above consensus 0.3%mom rise, and MBA mortgage applications. We also get the US Empire survey which will provide the latest snippet on business sentiment in the US. The consensus is looking for a small rise from 7.1 to 8.0. That said, in NY trading yesterday, the market started to latch on to the prospect of QE2 and thus ignored the better than expected retail sales data. In our view, QE2 is most likely to occur later this year or early next, with the November meeting as our base case.

Ahead of the US data, the UK will publish the next batch of labour market data. In Asian time, continued weakness in NZ credit card spending re-highlighted the weakness of the consumer and we expect the RBNZ to keep rates on hold at their coming meetings and to issue a rather cautious statement. In Australia, consumer confidence weakened somewhat on the month, but remains at relatively elevated levels. Despite the decline in consumer confidence and the overnight move in US rates, 5-yr Aussie swap rates climbed higher to 5.38% to the benefit of our paying recommendation. We are raising stops from 4.80% to 5.20%.

3. Current Trading Views The following trading ideas from the Global Markets Group reflect shorter-term views, which may differ from the longer-term "structural" positions included in our "Top Trades" list further below.

In FX: 1. Stay short $/CNY via 1-yr NDFs, opened at 6.7550 on 10 June 2010, with a target of 6.50, and a 1-day stop of 6.83, now at 6.6822.

2. Close short MXN/CLP, opened at 41.19 on 05 August 2010, for a potential gain of 6.2%.

3. Stay short EUR/AUD, opened at 1.3750 on 9 September 2010, with a target of 1.30 and a one-day stop on a close above 1.4150, currently at 1.3846.

4. Stay short INR/KRW, opened at 25.11 on 13 September 2010, with a target of 23 and a stop on a close above 26, now at 25.0383.

On Rates: 1. Stay short an equally weighted basket of 5-yr CDS spreads in Poland, Korea, China and Czech, opened at an average spread of 115 bp on 17 June 2010, with an initial target of 75 bp and a stop-loss of 140 bp, now at 103.0 bp.

2. Stay short UK inflation vs. long Euro-zone inflation through 5-yr zero coupon swaps, opened on 09 July 2010 at 1.63%, for a target of 1.2% and a close set at 1.85%, now at 1.42%.

3. Stay short 5-yr AUD swaps vs. 6-month rates, opened at 5.09 on 03 September 2010, for a target of 5.60 and a stop on a close below 5.20 (raised from 4.80), now at 5.35.

4. Hold steepeners in EUR 10s-30s vs. flatteners in GBP 10s-30s, opened at -35bp on 03 September 2010, for a target of 0 bp and a stop on a close below -50 bp, now at -32.9 bp.

5. Stay long 10-yr Italy vs. France, opened at 112 bp on 03 September 2010, for a target of 70 bp and a stop on a close above 130 bp, now at 108.8 bp.

6. Stay long 30-yr Greek GGBs, opened at 54c (ask) on 03 September 2010, for a target of 60c and a stop on a close below 50c, now at 55.20c (bid).

Equity Trading Strategies: 1. Go long EEM/SPX, opened at 0.0386 on 14 September 2010, with a target of +9% and a stop of -4%, now at 0.0386.

4. Recommended Top Trades for 2010 (opened on 02 December 2009 unless otherwise stated)

1. Stay short S&P 500 Dec10/Dec11 Forward Starting Variance Swap, opened at 28.20, with a target of 21, now at 29.85.

2. Stay long Russian Equities (RDXUSD), opened at 1645.9 for a target of 2050, now at 1642.38.

3. Stay long GBP/NZD, opened at 2.29, with a target of 2.60, now at 2.1112.

4. Close short 2-yr GBP swap rates vs. long 2-yr AUD swap rates on a 1-yr forward basis, opened at -268.5 bp, for a potential loss of 24 bp (inclusive of carry).

5. Close short 2-yr TRY rates through cross-currency swaps, opened at 8.77%, with a target of 12.0%, for a potential loss of 168 bp (inclusive of carry).

6. Close long 5yr credit protection in Spain vs. short 5yr credit protection in Ireland at 13 bp, opened at 70 bp, with a target of 20 bp, for a potential profit of 2.9% (inclusive of carry).

7. Stay long the GS FX Growth Current, opened at 103.5, with a target of 111.8, now at 104.8.

8. Stay long PLN/JPY, opened at 32.1, with a target of 37.5, now at 28.1339.

9. Stay long Chinese Equities (HSCEI), opened at 12616.01 on 01 April 2010, with a target of 15000, now at 12048.27.

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