London Open Update

The BOJ’s patience runs out

This week could be as big as last week for traders after the Bank of Japan stepped into the markets this morning to intervene after USDJPY fell to a fresh record low early in the Asian session of 75.35. Combined with a Fed meeting, ECB meeting, G20 meeting and to top it all off US non-farm payrolls on Friday, we have had a manic start to a pivotal week.

Themes:

The BOJ move is hardly surprising: Japanese officials have been talking down the yen and threatening intervention for weeks as USDJPY has been grinding lower. However, the move was surprising in terms of its timing since the G20 is coming up on Thursday and Friday and Japan will not want to put any diplomatic noses out of joint. However, it is worth noting that if the Europeans are trying to attract Japanese money to their EFSF SPIV then they may keep quiet on the FX front. However, the move is still a bit of a shock since other yen crosses had weakened significantly in recent weeks, such as EURJPY, which rose from just below 101.00 to 107.00 at last week’s close.

So why intervene? The BOJ can’t be seen as doing nothing if exporters are suffering and the currency threatens growth. The central bank could also argue that USDJPY had got out of kilter will fundamentals. For example, US 10-year Treasury yields had moved higher in October, which usually tracks USDJPY closely, thus it could argue that the yen was under speculative attack.

So what about the chance of success? The BOJ has had patchy success with unilateral action in the FX market. At the time of writing the yen is steadily strengthening after its massive sell off and is back below 78.00.Rumours suggest that the BOJ intervened to the tune of $40bn today, and the upward pressure on the dollar boosted most of the greenback crosses. However, in the past BOJ intervention has been a one-off, apart from after March’s earthquake. The reported size of today’s move and the fact that the G20 takes place later this week suggests this will be a single bout of intervention from the Japanese, at least in the near-term. Thus, we may see the FX market test the BOJ’s resolve and we could see USDJPY drift along with general risk appetite for the rest of this week. However, we would note that the BOJ has plenty of financial fire power so we could see further intervention, although perhaps after the G20.

I was asked an interesting question today: why can’t the BOJ have the same effect on the yen as the SNB has on the CHF? Primarily it is because the Japanese authorities have been far less aggressive in their intervention. They haven’t implemented a floor or set capital controls unlike the Swiss, which is why this intervention may not be as effective. Japan is a huge economy and if it was to follow the SNB it may incur the wrath of the US and other Asian economies– all of whom are major trading partners.

The Other big story is of course Europe. The debt deal attracted a lot of criticism in the weekend press and peripheral bond yields have widened again today. Italian bond yields have surged to 6.12%, very close to the 6.19% high reached in August before the ECB stepped in and bought Italian and Spanish debt aggressively, eventually pushing yields back down to a more sustainable 5%. The risk is that the ECB throws its support against Italy again, which would be positive for risk. But without that Italy looks extremely vulnerable at the moment and the euro is struggling to stay above 1.40 this morning.

There has been very little news flow today. Instead economic data is in focus. The Eurozone CPI estimate for October failed to moderate and remains at 3%. There was more bad news as high inflation is coupled with a rising unemployment rate. The rate for the currency bloc jumped to 10.2% in September from 10% in August. This leaves the ECB between a rock and a hard place – if the committee cuts rates then its price stability goal will be at threat, yet high inflation and rising unemployment is containing consumers and thus growth… Trichet passes the mantle to Mario Draghi tomorrow, at a very difficult time for the central bank.

Stocks have opened lower in Europe, led by the banking sector. Although more storm clouds are on the horizon than they were on Thursday, the stunning rally in risk for October deserved a pull back as profit taking takes hold. We expect risk markets to range-trade until we get some clear direction on central bank policy in Europe and the US, and the US labour market report on Friday.