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
rebecca, picking up from where we left off at the street light, my carry trade speculation was obviously not something i could know first hand…i probably picked the idea up from zero hedge &/or felix:
FX markets deal Japan another blow – If FX moves were measured on the Richter scale, this one would be a monster — the yen managed to strengthen by 4% against the dollar and almost 6% against the Australian dollar in a matter of minutes. This move is overwhelmingly due to technicals, rather than fundamentals: you don’t get jumps like this because people have donated a few million bucks in aid which is now being converted to yen. And on the face of it the move doesn’t make a lot of sense: countries’ currencies are just as likely to fall in the wake of a natural disaster as they are to rise. But what we’re seeing here is a function of ultra-leveraged hedge funds unwinding their carry trades. If you borrowed yen and invested in higher-yielding currencies like the Australian dollar or the South African rand, you made lots of money so long as the rate of appreciation of the yen was lower than the interest rate you were getting in the target currency. But when the yen starts to appreciate dramatically, you get margin calls, which force you to buy a lot of yen in an illiquid market, which in turn drives the yen up even further, which in turn not only increases the size of your margin call but also triggers a large number of stop-loss orders and other triggers embedded in exotic FX options. The result can be massive, as we’ve just seen.
Rebecca,
Japan debt to GDP off the charts, and now they have to rebuild.
http://en.wikipedia.org/wiki/List_of_sovereign_states_by_public_debt
Sell, sell, sell!
I’m not saying that the margin calls couldn’t have caused the crash – that would be the most likely situation, given the trigger and the yen appreciating to record highs. But now, after the models have all reset, the yen is still heavy. There’s a lot of speculation going on out there, and like I said on the Street Light, there’s an interest differnential effect at play here.
Usually the reference to the carry trade is with Mrs. Wanatabe and the retail investors who want yield and are now seeking Brazilian and Australian markets to get it. Those flows, for all intents and purposes, are not causing the shift in the yen right now (as I said, Nomura has seen no net-inflows of retail investor capital back into japan).
Rebecca
I’m sure that the BoJ would just love you for it!
“In the chart above, a decline in the USD/YEN is an appreciation of the Japanese yen and a depreciation of the US dollar”
Good, I get to ask a question that has been bugging me. I would read USD/YEN as US Dollars per Yen. But it shows the opposite. 80 means that you get 80 yen per dollar in exchange. Why the apparent opposite meaning?
Trivia question: How much is 1/100 Yen?
Answer: 1 sen.
More trivia: Early in the 20th century 1 Yen was roughly equal to 1 US Dollar. The rough equivalence of the sen and the cent was a happy coincidence. Even today, there are elderly Japanese in the U. S. who call a One Dollar Bill Ichi En Satsu (One Yen Bill). 🙂
sammy,
Explain…………………….
How come Japan is hugely in debt, while its FX has to hold shy of a trillion in US treasury “assets”?
Min,
You are great! I love your technical questions! FX notation is confusing. One effectively reads USD/YEN mathematically as YEN divided by USD, so its the number of yen per 1 USD or price of 1 USD in yen.
Thanks for the trivia. I’m not sure what the implication is, though.
Rebecca
ilsm,
Japan government debt is $7.5 Trillion
http://www.visualeconomics.com/gdp-vs-national-debt-by-country/#
Because it runs current account surpluses, i.e., it saves more of its income internationally than it spends. Last I counted, Japan runs a trade balance surplus against the US of roughly 6.5%. They sell goods to us foreigners and receive dollars for it – they can turn around and buy dollar goods or they can save it in dollar assets. Net debt, which takes into account public assets is not nearly as big, roughly 120% of GDP in 2010, according to the IMF.
BTW Sammy, you can get all of this from the IMF directly under their World Economic Outlook database (rather than wiki and other blogs) – better resource, in my view.
Rebecca
Many thanks, Rebecca. 🙂
As for the trivia, it was after midnight, and I remembered how the owner of a Japanese restaurant in NYC used to call one dollar one yen. 😉
Your readers might be interested in how to treat their radioactively contaminated drinking water:
http://crisismaven.wordpress.com/2011/03/22/dangers-properties-possible-uses-and-methods-of-purification-of-radioactively-contaminated-drinking-water-e-g-in-japan/
A Japanese translation seems underway, see comment by Takuya there. Maybe someone wants to help with other languages?
Your readers might be interested in how to treat their radioactively contaminated drinking water:
http://crisismaven.wordpress.com/2011/03/22/dangers-properties-possible-uses-and-methods-of-purification-of-radioactively-contaminated-drinking-water-e-g-in-japan/
A Japanese translation seems underway, see comment by Takuya there. Maybe someone wants to help with other languages?
Your readers might be interested in how to treat their radioactively contaminated drinking water:
http://crisismaven.wordpress.com/2011/03/22/dangers-properties-possible-uses-and-methods-of-purification-of-radioactively-contaminated-drinking-water-e-g-in-japan/
A Japanese translation seems underway, see comment by Takuya there. Maybe someone wants to help with other languages?