Japan can’t scare off safe haven status

 
Philip Salter
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THE yen will continue to strengthen against major currencies. No matter the actions of Japan’s authorities, attempts to bring it down are destined to fail. It is not as though Japan’s leaders haven’t been trying – the economy has been mismanaged for decades. But interventions and gargantuan government debt have done nothing to dissuade the forex market from its instinct that in adversity, the yen is the place to be.

THE COST OF INTERVENTION
On Monday, the Bank of Japan (BoJ) managed to dig the yen out of its record ¥75.35 against the dollar, but at an estimated cost in the region of $100bn (£64bn). This was a short-term fix and has since been trading in a tight channel just above ¥78. It won’t stay there for long.

Chris Towner of HiFX thinks “the timing of the intervention was intentional.” He says “they patiently waited for the Europeans to come up with their plan and as risk-on returned to the market on the last day of October, they intervened.”

Interventions have failed on its two previous attempts this year and the latest move will follow suit. “Back in August,” says FairFX’s Rishi Patel, “the ¥77 handle in dollar-yen was simply ineffectual.” The markets returned back to that level within a few days. He thinks although Monday’s “intervention was significantly more than the August intervention, so far the impact has been limited and there has been no follow through.”

A HARD RAIN
The Eurozone’s leaders are forever claiming that its economies are better than the markets give them credit for. In contrast, Japan is in the rather peculiar position of trying to convince investors that they have too much faith in them. In reality, both are in a significantly worse state than most are willing to admit – but for now, the Eurozone’s liquefaction takes centre stage. As Markos Solomou, risk manager at Easy-Forex explains, the seemingly never-ending Eurozone crisis and all of the ongoing uncertainty leads investors to seek safe havens. Towner thinks the Eurozone has caught Japan between a rock and a hard place: “We have seen the Japanese yen strengthen due to risk aversion and then when risk aggression returns to the market, the US dollar weakens and by default the yen strengthens.”

Deflationary Japan holds some security for forex traders. Yannick Naud of Glendevon King notes that as long as the inflation gap between Japan (year-on-year expected 2011 CPI of -0.2 per cent) and the US (3.2 per cent) remains wide, we should expect the yen to appreciate further in the medium term. Kathleen Brooks thinks the authorities will fail not only because the dollar-yen is a highly liquid trade in a $4 trillion market, but also due to the size of its economy, currency manipulation of the sort required would become a serious diplomatic matter.

As Michael Derks, chief strategist at FxPro surmises: “In a world where many of the major currencies have serious doubts attached to them as a reliable store of value and with question-marks over the safety and security of their banking systems, it is hardly surprising that the yen has so many friends.”

ON A DIME
Traders had been speculating and guessing an intervention was coming says Spreadco’s Ian O’Sullivan. BoJ mutterings tipped off traders, however, he says “when it did happen, it caught most traders completely off guard.” For some this was no bad thing: “Anyone who had been buying dollar-yen in the last week of October just below ¥76, with a stop loss below ¥75.50, found themselves in a lovely position, as the stop escaped, just, before it launched over 300 pips skywards.” O’Sullivan says traders are willing now to close out and take the opposite trade – expecting the BoJ to eventually succumb to the pressure.
Even though it is destined to fail in the long-term, traders need to beware, as the BoJ is serious about interventions, which could upset trading conditions. Towner warns that Japan, in protecting its currency from strengthening, has unlimited reserves. It can print its own money to buy the dollars for the intervention.

Derks advises that although “intervention always complicates trading, it is never a reason to avoid trading a particular currency. The answer”, he says, “lies in attempting to determine at what level the central bank will intervene, and neutralise positions beforehand.” Derks thinks Australian dollar-yen is also an interesting pair to keep an eye on: “If we now revert to risk aversion like we did through August and September, it is hard to see how this pair would not fall further.”

Japan’s fiscal and monetary authorities are in a game of snakes and ladders, in which the snakes are out to get them and the ladders lead to nowhere.