Source: Zhitong Finance

The yen has fallen far below the so-called “red line” level set by Japan, and traders were shocked by the speed of its decline, which made the market question when exactly the authorities would start buying yen to provide support, and why they haven't done so yet.

After the Bank of Japan said last week that financial conditions would remain relaxed, the yen fell below the 160 key level against the US dollar on Monday for the first time since 1990 due to insufficient liquidity due to local public holidays. As of press time, the exchange rate had recovered slightly to around 159.40.

Policymakers have repeatedly warned that Japan will not tolerate depreciation if it depreciates too much too fast. Japan's Finance Minister Shunichi Suzuki also reiterated after the Bank of Japan meeting that the government will respond appropriately to exchange rate fluctuations. Earlier this month, he also expressed concerns about the depreciation of the yen to US Treasury Secretary Yellen. Market participants believe this has laid the foundation for intervention in the foreign exchange market.

Jane Foley, head of foreign exchange strategy at Rabobank, wrote in a report to clients: “If foreign exchange intervention is to successfully reverse the USD/JPY exchange rate, the improvement in Japanese economic data will probably have to match the slowdown in US economic growth and the weakening of price pressure. This indicates that Japan's Ministry of Finance's efforts to scare off speculators from further increasing short positions in the yen may continue for weeks.”

Masato Kanda, the top currency official, said in February that the yen exchange rate rose by 10 points against the US dollar within a month is considered rapid. In the past month, the exchange rate of the yen against the US dollar rose by about 7 points, but last week alone it fell by more than 2%, and the cumulative decline so far this year has exceeded 10%.

Chris Weston, head of research at Pepperstone Group Ltd., said: “The authorities may say that they have not set a target level themselves, but they do keep a close eye on trends and the pace of change. The current level indicates that they must act as soon as possible, otherwise they may face a credit crisis.”

One reason Japan's apparent reluctance to act may be that intervention alone cannot change the huge interest rate gap that has contributed to a certain extent to the fall of the yen. Although the Bank of Japan has pulled the country's interest rate from a negative range, it is still far from reaching a level that would attract investors away from the US and other countries with higher yields.

Goldman Sachs strategists said that the global macroeconomic context indicates that the yen will weaken further, which may make it difficult for the intervention to succeed.

A team including Kamakshya Trivedi, head of global currency, interest rates and emerging markets strategy, wrote, “Our basic expectations of steady growth, gradual policy adjustments, and upward risk in forward interest rates are a very negative combination for the yen. The only question, then, is to what extent will Japanese policy makers stop the yen from depreciating, but we think the tools are limited.”

However, Goldman Sachs strategists added that if the yen continues to perform worse than other assets like last Friday, the risk of intervention will rise sharply. According to reports, the yen exchange rate fell 1.7% on the same day to around 158.30 yen per US dollar, the biggest drop in six months.

George Saravelos, head of global foreign exchange research at Deutsche Bank, said that the weakening of the yen is not necessarily a bad thing for Japan. He wrote in an email that the depreciation of the yen did not cause inflation problems; on the contrary, it boosted the value of overseas assets held by Japanese investors.

At a press conference after the Bank of Japan made its policy decision last Friday, Bank of Japan Governor Kazuo Ueda also downplayed the impact of weak yen on inflation, saying that the exchange rate continues to benefit the economy by boosting demand.

Saravelos said, “Japan is pursuing a policy of moderately ignoring the yen. If the market becomes disorderly, the possibility of intervention cannot be ruled out, but it is worth noting that Kazuo Ueda downplayed the importance of the yen at Friday's press conference and stated that there is no urgency to raise interest rates.”

trading strategies

Traders, for their part, seem opposed to Japan's successful intervention. According to data from the US Commodity Futures Trading Commission (CFTC) since 2006, on the eve of the Bank of Japan meeting, hedge funds and asset management companies are betting on the weakening yen reached the highest level on record. Meanwhile, anxiety is rising, as evidenced by the sharp rise in indicators of the yen's implied volatility against the US dollar last week.

Pepperstone's Weston said that while shorting yen at current levels is risky, bearish speculators may plan to buy USD/JPY again at lower levels where officials intervene.

He said, “I can imagine a hedge fund setting a limit order of 400-500 points below the spot to catch intervention. Of course, they are confident that any sharp decline will return soon.”