Tuesday, September 28, 2010

Yen intervention: back to square one

On Sept. 15th the Bank of Japan (BoJ), on behalf of the Ministry of Finance (MoF) intervened in the currency market to weaken the Yen (JPY). That day the JPY moved from 83.0 to 85.7 against the USD and from 107 to 111 against the EUR.

Where are we now, almost two weeks later? Well against the USD the JPY is back to 83.8 (as of Sept. 28), basically the level it was the day of the intervention. Against the EUR the JPY has managed to weaken a bit more and is now at 113 - this is obviously due to the strength of the EUR versus the USD.

The intervention by the BoJ is the first one since 2004 and was pretty much anticipated but not coordinated with other major central banks. Hence the success of the intervention could be short-lived. Previous studies of JPY intervention show that success is more likely with a coordinated approach and/or if it is done in large amounts. The Nikkei reported that the BoJ intervened with a record JPY2 trillion.

A comprehensive study of the effectiveness of JPY intervention in the 1991 to 2000 period by Fatum and Hutchison (“Effectiveness of official daily foreign exchange market intervention operations in Japan”, NBER Working Paper 9648, April 2003) highlighted a number of conditions that are consistent with successful JPY intervention. A successful intervention was one that led to a change in direction consistent with the intervention move (i.e., USD/JPY rose post the buying of USD/JPY). The study showed that interventions done in conjunction with the US Federal Reserve were more likely to succeed than those which were unilateral. It also showed that ones which consisted of large amounts of intervention (over US$1 billion at that time) were more successful than those which intervened in smaller amounts. The authors note in their study of JPY at this time that “Uncoordinated small-scale intervention does not appear to be a useful policy.” In the period post this study almost all the intervention was unilateral.

For the JPY to weaken again, the BoJ may be forced to convince the Fed and the ECB to participate in the next round of intervention. We found it very unlikely that the Americans and the Europeans, given their own economic problems, would favor the idea of letting their currencies strengthen at this time.

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