Column-Next Bank of Japan intervention could be to sell yen: Mike Dolan By Reuters

By Mike Dolan

LONDON (Reuters) – If Japan’s government is thinking ahead, it may plan to rein in its faltering yen instead of propping it up.

A two-year game between speculators and Japanese authorities – involving increasing bets against the yen on widening interest rate differentials with other G7 economies – ended this month with the cat licking its lips, even if it was suffering from some indigestion.

The yen’s plunge to near four-decade lows, which played no small part in the exit of another Japanese prime minister this week, drew months of government warnings and then, eventually, periodic bouts of yen-buying intervention from the Bank of Japan.

But when the BOJ finally raised interest rates again on July 31 and warned that more would follow, the “carry-trade” bubble burst and the currency turned violent – triggering a dizzying but brief spasm of stock market volatility in and around Tokyo. the world.

Job done?

There are a lot of opinions that think it might end up working a little too well.

Going back to long periods in recent history where the BOJ was either buying or selling the yen every two to three years to close out its moves, there is every chance that the currency will quickly break out on the strong side again.

No less than Nomura, Japan’s largest brokerage, raised the prospect even before last week’s blowout.

“We may need to start considering potential foreign exchange interventions by the Ministry of Finance (MOF) to limit yen strength rather than weakness,” its macroeconomic research team told clients on Aug. 2, adding that it is not still the “base case”. “

“The history of interventions tells us that yen-buying interventions have been followed by yen-selling interventions to limit the yen from strengthening too much.”

TENDENCY TO EXCEED

And until about 10 years ago, at least, that was really the routine swing of the pendulum.

The most celebrated episodes of currency intervention were the G5 and G7 collective forays of 1985 and 1987—with the former Plaza Accord to weaken the dollar, followed two years later by the Louvre Accord to shore up the greenback. The dollar/yen was at the center of these swings.

But yen-specific interventions by the Japanese authorities alternately led to the official buying and selling of the yen at extremes between 150 and 75 to the dollar every few years in the two decades after the property crash of the 1990s.

The extremes of Japan’s low interest rates since that crash and the inflation and deflation resulting from speculative trading paved the way for volatility and overshoots in both directions during that period.

The routine “ebb” was yen weakness, and the “flow” was exaggerated snapbacks in times of stress or volatility as carry trades emerged or Japanese investors fled repatriated investments abroad. And that was a key reason why the yen acted as a “safe haven” during any market shocks during that period – something that compounded the moves in the mix.

But after the Great Financial Crisis of 2007-2008, there followed a decade in which interest rates in virtually all Group of Seven members gravitated close to Japan’s zero level – stifling carry-trade temptations and allowing for a relatively stable yen exchange rate to effectively eliminate the BOJ’s hyperactive currency. office.

In fact, there was no confirmed intervention between the extraordinary earthquake and tsunami shock of 2011 and 2022 – when post-pandemic and post-invasion Ukraine interest rates rose elsewhere isolated Japan back to zero again – renewing the transport exchange in the business.

The wild swings of recent weeks are just a reminder of the currency’s inherent tendency to overshoot.

PERFORMANCE GAPS NORMALIZED?

Roll forward and it’s not hard to see where a burst of yen strength could come from here. As US and other G7 policy interest finally eases and carryover trade frees up, Japan may feel emboldened to further “normalize” – increasingly confident that its decades of post-1990 deflation have ended.

Even if markets now believe that Tokyo may be even more cautious about raising interest rates again for fear of upsetting the stock market, as it did earlier this month, the latest GDP update may be encouraging, a new prime -minister will be in town soon, and the US Fed. The Reserve will likely start cutting rates next month anyway.

Yields on Japan’s benchmark two-year bond fell back below 30 basis points from 15-year highs of nearly 50 bps earlier in the month. Given that alone, any suggestion of higher rates will warrant a significant repricing.

But the yield gap with the rest of the G7 has already narrowed.

Two-year yields against US Treasuries fell 1.1 percentage points in just over three months, with USD/JPY only reacting with a three-month lag to this recovery. It would take another 1.7 point narrowing of that spread to return to the 10-year average — and that could happen relatively quickly if it comes from either side.

Fear of Donald Trump’s broad trade tariff commitments if the former Republican US president wins the Nov. 5 election could be another reason for Japan to hold back a bit. But Trump is no longer the favorite either in the opinion polls or in the betting markets.

While another move to raise rates could be partially self-defeating if the yen’s strength hits exporters and the broader Japanese economy, the flip side of the currency’s strength is lower import prices, which allow for more significant increases in real wages to provide the holy Grail of domestic consumption growth.

But if the strength of the yen goes too far too fast – then there is always an intervention to calm it down.

The opinions expressed here are those of the author, a Reuters columnist.

(by Mike Dolan X: @reutersMikeD; Editing by Paul Simao)