A recent cover of The Economist had a picture of Japanese Prime Minister Shinzo Abe in a Superman cape, ready to fight the evils of the world and get his country’s economy on track, with the help of his sidekick, Bank of Japan Governor Haruhiko Kuroda. From an FX perspective, however, it can be argued that Abe is a great deal more like Harry Houdini than Superman, so far.
Abe’s verbal intervention efforts to weaken the yen have been masterful and, more importantly, wildly successful. Just the thought of a more proactive Japanese government, led by Abe, saw dollar-yen rise more than five big figures from just over Y77 in September 2012 to Y82.85 in November.
Once it became clear that Abe had a real shot at becoming Prime Minister, dollar-yen rose more markedly, with gains stepping up after the December election results. Additional verbal intervention from new Finance Minister and Deputy Prime Minister Taro Aso, extolling the virtues of a weaker yen, helped dollar-yen rise into year end, closing at Y86.75 on 31 December.
Speculation about what the BOJ might do helped keep dollar-yen frothy in 2013, with the pair rising big figure by big figure, with no meaningful correction in the early months of the year. By the time the BOJ did announce its shock and awe quantitative easing measures in early April, dollar-yen was trading at Y96.35.
A 25% run up in dollar-yen over the course of seven months has to be one for the history books in terms of central bank intervention, verbal or physical. And the BOJ did not spend one dime in intervention; it merely allowed the market to speculate about what measures would be taken. Abe dangled the prospect of regime change in front of Japanese and global investors and they believed him. Dollar-yen and the Nikkei 225 rose accordingly.
Compare this to less successful and much more costly BOJ FX intervention in yesteryear. As we discuss in The Foreign Exchange Matrix (Harriman House, February 2013), the BOJ spent roughly $300 billion in 2003 to 2004 to try to prevent the yen from strengthening.
In March 2011 and October 2012, the central bank intervened to the tune of roughly $58 billion and $128 billion respectively. These intervention efforts were successful initially, but eventually the market became bolder and willing to bet against the BOJ. In addition, with the euro zone crisis escalating, global investors were in need of an alternate G-3 safe-haven other than the dollar. The yen (and Japanese government bonds – the second largest bond market behind the US) offered preservation of capital, albeit with meagre returns.
The key to successful intervention is timing, as well as convincing world financial markets that you mean business. In this, Abe had the wind at his back as he promised bold measures to get the Japanese economy on track. Talk of a near doubling of BOJ asset purchases (on a yearly basis), the prospects of Japanese investors moving sizable amounts abroad in search of higher returns and/or the government setting up a new fund to buy overseas assets, all fed right into the market’s desire for a new larger FX trend – that of yen weakness.
Those who didn’t buy dollar-yen sub-Y80 could buy the pair sub Y90 and still make money. Dollar-yen kept rising from November 2012 to April 2013, mostly on speculation of what the government or BOJ would do, not actions taken thus far. Like master magician Houdini, Abe had the audience so busy looking at the spectacle of what was going on, that no one bothered to look for the trap door, the wires or other tools of the trade that allowed the magic trick to work. The market wanted Abe to pull a white rabbit out of his hat and applauded him loudly by selling yen when the rabbit appeared in April, as the BOJ finally did announce its bold measures of Y60 to Y70 trillion dollars in annual asset purchases.
Global investors, clamouring for new and more innovative legerdemain, sent dollar-yen from levels around Y96.35 just after the April BOJ decision, to highs near Y103.75 in May, accompanied by a new push higher in the Nikkei 225, which was up over 50% year-to-date, before the recent 7.3% sell-off.
With dollar-yen retreating back below Y100 again now in early June, the crowd has grown impatient, but remains excited about the prospects of Abe’s final and potentially greatest magic trick. This is the illusive third arrow, which involves, as The Economist says, “sweeping reforms designed to stimulate the economy.”
For currency players, Abe’s success or failure will be only one factor driving the yen. In addition, yen direction will hinge on whether global investors begin to take money out of Japanese stocks and whether Japanese investors, as has been much debated for many months now, finally do decide to seek out greener pastures abroad.
Currently, the market still thinks dollar-yen is heading to Y105, Y110 and perhaps even Y120. Sleight of hand has levitated dollar-yen from Y77 to over Y100, but the pair won’t hold these lofty levels and keep rising unless and until there are clear signs of recovery in the Japanese economy and realistic expectations that the BOJ will reach its 2% inflation target within its two-year deadline.