Yen Intervention

It used to be a good game for carry trade when the yen is trading above 105 with almost practically zero funding cost. Now, the USD has crashed with Yen cross at below 89 and investors who had enjoyed a handsome return from borrowing cheap yen and using that to buy high yielding currencies are running for cover. They quickly found that the yen carry trade is akin to picking up pennies in front of a steamroller…. Yen has gone up 28% against the USD since June 2007 (+20% against RMB, +21% against SGD, +31% against IDR and +43% against KRW).

That in turn, makes Japanese exports significantly more expensive than their Asian competitors. That is why markets are expecting a weaker recovery for this economy. And that lead to a speculation that Japan could return to recession as soon as the fourth quarter of this year, hence will drive the authority to intervene to keep yen competitive.

Japan’s new ruling party, the Democratic Party of Japan, entered office last month and the newly appointed finance minister, Hirohisa Fujii was happily to publicly comment on exchange rates. His initial remarks that a strong yen could actually be good for the economy caught the markets by surprise and sent the yen soaring even further. Since then, the minister had done an about face, joining other major countries with verbal threats against the strength of their respective currencies.

Japan has reputation for being sensitive to movements in the currency markets and the last time Japan intervened to weaken the yen was between 2003 and 2004. Over the course of 126 days, the Ministry of Finance purchased $135 billion and sold yen in the open market and ultimately sent the yen 11% lower.

But the overall success of interventions in changing the long-term path of a currency is not great. It tends to have a higher success rate when countries act together in support of (or against) the same currency. These coordinated interventions will have a greater spillover effect on other currencies.

Last week, leaders from the G-7 met in Istanbul and the probability of a coordinated response in currencies is high. And for Japanese exporters dealing with a yen near 14-year highs against the dollar – that will spell relief.