It’s lonely at the top: now it’s up to the Bank of Japan to hold the yen down

Wow, FX space is totally rattled this week: the yen hit 76.25 against the dollar at the end of the day on March 16 and has since rebounded to current levels 80.90 (1:50pm in NY on 3/18). What happened over this time span? Mass speculation on yen appreciation due to earthquake-related repatriation, followed by technical levels being hit that drove the yen up against the dollar, and a collapse of the dollar against the yen (spike downward in the chart below). And then yesterday the G7 central banks (the Bank of Japan, Bank of England, European Central Bank, the Federal Reserve, and the Bank of Canada) agreed to coordinate a weak-yen effort. Today the yen is off 2.7% against the dollar.

Note: In the chart above, a decline in the USD/YEN is an appreciation of the Japanese yen and a depreciation of the US dollar. The chart above illustrates the daily fluctuation of USD/Yen since the Tōhoku earthquake on March 11.

The coordinated depreciation of the yen against its major trading partners is ‘concerted’, and such an effort has not occurred since September 2000 when the G7 bid up the euro. The yen effort is very different, as I’ll explain below. Furthermore, ongoing weakness in the yen against the rest of the G7 currencies depends on further actions by the Bank of Japan into next week and beyond.

Some thoughts:

* In 2000 the wedge between the eurodollar spot and its PPP estimate of fair value diverged throughout the year. The spot rate became increasingly undervalued, hitting a wide in October 2000 (according to Bloomberg estimates of PPP). This seems to be a traditional initial condition for intervention. In contrast, though, the USD/YEN spot is seriously overvalued according to a similar measure of PPP fair value. I should note that currency fair value is a contentious topic. (more after the jump)

* The NY Fed makes available balances through 1999 only, so I am unable to ascertain the impact on the Fed balance sheet of the coordinated efforts from the 1987 Louvre Accord nor the 1985 Plaza Accord . I digress. In the 2000 effort, the euro bottomed in 9/21 at 0.8460 in dollars during the day, reaching an intra-day high of 0.8992 on 9/22. The closing impact of the G7 coordination was roughly a 2.7% appreciation of the euro against the USD. Efforts, however, were quickly retraced (see chart below).

* We are already there in yen space: the yen is down 2.7% in just one 24-hour session. It’s likely that this effort lasts throughout next week, since (1) a retrenchment of the dollar would challenge global central bank credibility, and (2) the statement is more explicit in its mention of “readiness to provide any needed cooperation”.

* In 2000 the Fed purchased roughly 10% of its stock of euro holdings, or $1.3 bn worth of euros (see second table below). Using 2000 as a guide, this would imply that the Fed purchases roughly $2.3bn this time around. However, given the size of the ‘model’ trading flows and technical barriers, this time’s flows are likely to be bigger. We’ll see in coming months when the Fed releases its FX holdings update.

* There is a limit to the Fed’s buying of yen, since the Fed is selling yen assets. The Fed and the Treasury (the Fed manages two accounts of FX holdings, the SOMA and ESF account for the Treasury) hold $23 bn in yen-denominated assets (see second table below) – that’s an absolute upper bound on purchases, although FX swaps do allow some room for maneuvering (although I find it very unlikely that the Fed would print currency for this effort). In 2000, the Fed purchased roughly $1.3 bn euro – that number should be at least doubled this time around, given that FX markets are bigger now. In comparison, Wall Street estimates that the BoJ bought $12bn-$40bn..

If there’s going to be succes, it depends on the Bank of Japan’s flows, not those of the other central banks.

My take is that given the size of today’s move, the 2000 effort was not nearly as concerted as has been demonstrated thus far. Next week will be interesting. The goal, I guess, is to get the currency back into a range that will not be prone to technical bounces. I think that the BoJ’s going all in.

Rebecca Wilder

Chart and Table Appendix:

Eurodollar in 2000

FX holdings in 2000

FX holdings in 2010

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