Currencies | Oct 15 2012
– Japan suffering from strong yen and weak domestic economy
– Risk of currency intervention is rising
– CBA offers some trade ideas if BoJ intervenes to weaken the yen
By Chris Shaw
The combination of a strong yen, weak domestic economic data and a low stock market are, in the view of Commonwealth Bank, working to increase the risk the Japanese Ministry of Finance requests the Bank of Japan (BoJ) intervenes to weaken the Japanese currency.
As well, CBA's currency strategist, Joseph Capurso, sees potential for concerns with respect to the looming US 'fiscal cliff' to strengthen safe haven currencies such as the USD/JPY. This suggests any sudden fiscal cliff-induced fall in the greenback relative to the yen could act as a trigger for BoJ intervention.
Recent rhetoric suggests intervention is becoming more likely, as recent BoJ meeting minutes indicate the Japanese government is concerned the rapid appreciation of the yen poses significant downside risks for the Japanese economy.
This has prompted the government to indicate it will take decisive measures with respect to the level of the currency, especially given the view the yen is overvalued. As well, Capurso points out with the government lagging in opinion polls, there is a need to be seen to be acting on the strong yen.
Capurso notes the trade weighted index for the yen is near levels where there has been intervention in the past, as is the Nikkei Index. Supporting intervention moves is the fact Japanese industrial production has decreased in five of the past seven months, which increases the risk the Japanese economy contracts in the September quarter.
In Capurso's view there is little chance of intervention being successful in weakening the currency for any significant period, as history has shown periods of intervention have only a short-term impact. This reflects the lack of coordinated action with other central banks and the US Fed's intention to keep the funds rate low. This suggests the US-Japan swap spread, which is an important influence on the USD/JPY rate, will stay at very low levels.
The potential for intervention opens up some possible trades according the Capurso, the first being to short the USD/JPY after any BoJ intervention to weaken the yen. As Capurso notes, typically the USD/JPY falls back to pre-intervention levels within two weeks of intervention by the BoJ. This implies an opportunity to initiate short USD/JPY positions in the days after any initial intervention activity.
The other potential trade identified by Capurso relates to currency volatility, as fears of a US recession induced by the fiscal cliff could see currency volatility increase significantly after the Presidential election.
At present USD/JPY two- and three-month volatility is at very low levels, with indicative prices around 6.85% at present on a 2-month basis. A lift in recession fears would likely boost this volatility towards the end of the year, so Capurso recommends buying two-month volatility around current levels.
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