Keith Underwood 3 Comments
  1. Verbal intervention is not a viable long-term strategy.
  2. Unless other major central banks join in, it fruitless.
  3. Intervention only provides better levels for hedge funds to enter the trade.

For those of you that only know verbal intervention as HID (your significant other) yelling at you to do something, in financial markets it is the action of a very influential person (central bank person or Ministry of Finance person such as Taro Aso in Japan) telling anyone that will listen that they are not pleased that the market (traders, money managers…that’s right…smart people) has not priced an asset to their thinking/liking. So, just like listening to HID when they are yelling, you jump and take notice to legitimize HID, only to resume what you were doing after they depart. Financial markets are no different.

The US dollar vs. Japanese Yen exchange rate is presently a classic example of such policy shenanigans. Aso has said, “If one-way movement continues, intervention is only natural” and “I feel that the fairly precipitous movement has become one-way”. He’s talking about the strength of the Yen and is verbally trying to weaken the currency. His verbiage has weakened the Yen to 109.10 from 106, a 3% move just from publically threatening to intervene. Not a bad effort really on his part but the currency market is the most liquid and heavily traded market in the word and no talking head can verbally turn around the fundamental price of a currency.

Readers of my blog will recall a recent piece that I penned entitled “Negative Interest Rates: A Disincentive to Risk” on the 19th of April, where I outlined just how bad negative interest rates are to an economy. Think about it for a minute…your savings are not a good thing and your government wants savers to pay interest, largely because of their failed policies. It’s a f_ing disaster and Japan keeps thinking that this will help their moribund growth and inflation figures. There is a cliché that comes to mind about expectations that outcomes will be different with the same inputs, but we are dealing with politics at the end of the day and making economic sense is not a requirement to policy decisions.

Looking back over the decades of currency intervention by central banks, one sees the road littered with failed attempts of one central bank to stem the tide of the entire currency market. Yes, they have raised short-term interest rates and penalized speculators for not accepting what the central bankers have repeatedly said as ‘economic reality’ of where the correct currency rate should be, but ultra-successful currency intervention has rarely been achieved on a sustained basis. Between 1985 (Plaza Accord) and today, there are greater than 45 instances of currency interventions that took place either unilaterally or on a coordinated basis. Most recently, the Russians, Brazilians, and the Swiss all have had a hand in trying to muscle the market. One has to ask the SNB how much their franc cap actually cost to implement before the fateful day of 15th January 2015 when it abandoned the cap.

In just about every instance of intervention, the actions were supported with verbal intervention along side to justify their actions. The Japanese MoF is no different with this latest attempt to weaken the yen. Ultimately, its folly to expect anything other than a short-term move and hedge funds will take advantage of the weakened Yen to buy at better levels that has been provided by verbal intervention.

Smart money (code in the FX market for hedge funds) knows very well that the jig is up in Japan. Their growth is slowing (again) and inflation is (insert hopeful word her) thinking. The world’s third largest economy is flat lining and the doctor is shouting ‘intervention stat!’ Intervention won’t help the overall economy and the prospect of further yen strength because of global risk aversion will soon overtake market sentiment. Hedge funds are using the recent run up to 109 as an entry point to buy Yen against the US dollar knowing that this verbal intervention will eventually run its course and fail. In their risk meetings, the portfolio managers are even preparing for an actual physical intervention by Japan and asking where they can buy Yen in the event the rate might trade to 112.50 or even 115. They will watch and wait for their macro trade to develop as Japan provides them with the better entry point for their trade. I love the irony.

I’m not bullish on the outlook for the global economy. I’ve raised the red flag over negative interest rates, the rally in gold, the persistence of US treasury purchases, and of course the strengthening Yen. The Japanese attempt to weaken the Yen will run its course and an eventual reversal will see USD/JPY to 105 where Taro Aso will authorize the physical act of weakening the Yen, having drawn a line in the sand (not Obama’s red line). The next USD/JPY level down to 100 would be a political headache for the Abe administration and for Japan Inc. as well.  Anyone see Toyota’s latest rant about a strengthening Yen driving down profits? Oh dear. Buy Yen. 

 – Quick, discreet, and so worth the risk. 


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