As corrections go, the price action in USDJPY on Thursday was violent as it plunged from above ¥99 to below ¥96 in less than two hours.
Citi, the world’s second-largest FX bank according to the Euromoney FX Survey, saw record volumes traded on its systems, with the yen accounting for 43% of the turnover.
Indeed, yen volatility jumped to its highest level since March 2011. Then the Japanese authorities purchased ¥693 billion of dollars in a bid to stem yen strength, temporarily lifting USDJPY from a low of ¥76.25.
| USDJPY one-month at-the-money implied volatility spikes higher |
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The fact the slide in USDJPY on Thursday ran its course around the nice round figure of ¥95.50 prompted some to speculate that Japan had intervened in the market again to weaken the yen.
That talk was scotched, however, with Taro Aso, Japan’s finance minister, stating overnight that “we are carefully watching, but we don’t have any immediate intention of taking action, such as intervention”.
Those comments gave traders the green light to test the ¥95.50 level in USDJPY again, but quite why the alarm bells are not ringing louder in Tokyo can be seen from the context of a surge in yen strength.
First, it came as a result of a broad sell-off in the dollar as the currency corrected the recent strength it has garnered from speculation that the Federal Reserve was set to start considering scaling back its quantitative easing (QE) programme.
Investors headed into this week heavily long of the dollar, leaving it vulnerable to a correction as traders speculated that weak data – such as the US employment report, which in the event came in slightly above expectations – could push back Fed tapering of purchase plans.
It was not, in other words, just the yen that strengthened sharply – the euro, sterling and Swiss franc all notched up multi-month highs against the dollar amid a scramble to unwind positions.
The Japanese authorities simply do not have firepower to stand in the way of that type of global re-positioning. Furthermore, while the dollar plunged, 10-year US Treasury yields held up above 2%, suggesting the currency’s drop might be overdone in any case.
Second, although the yen has been the best-performing currency since the dollar peaked on May 22, rising nearly 8% from an intra-day high of ¥103.74, it is still down nearly 20% since November – just before Japanese prime minister Shinzo Abe returned to power with a promise to reflate the country’s economy and weaken its currency.
As Ulrich Leuchtmann, head of currency research at Commerzbank, puts it: “The extent of the recent USDJPY consolidation seems quite sufficient from the point of view of the impressive rise recorded beforehand. Once the market has calmed down, we are likely to see some good entry levels in USDJPY.”
Admittedly, further yen strength might set off alarm bells in Tokyo over intervention, and despite Aso’s comments it is by no means off the table. However, many believe the yen will continue to trend lower as a result of the massive QE plans introduced by the Bank of Japan (BoJ) in April.
“We remain comfortable with our view that the yen will likely resume its weakening trend consistent with weakening economic fundamentals,” says Lee Hardman, currency analyst at Bank of Tokyo-Mitsubishi UFJ.
“The aggressive BoJ monetary easing should begin to encourage a pick-up in yen-weakening capital outflows from Japan in the years ahead, especially when yields overseas begin to pick up as the global economy strengthens.”
Of course, worries over whether Abenomics is working have been raised by the seeming reluctance of Japanese institutions to send capital abroad.
Some of those fears might have been eased by an announcement on Friday from Japan’s Government Pension Investment Fund, the giant asset manager that has ¥111.9 trillion under its control.
It said it will cut its allocation from domestic bonds (from 67% to 60% of total assets) and reallocate more funds to foreign stocks (from 9% to 12%), foreign bonds (from 8% to 11%) and domestic stocks (from 11% to 12%).
Still, data from Japan’s ministry of finance (MoF), as can be seen in the chart below, have shown a marked reluctance from Japanese institutions to invest abroad. Indeed, they have been repatriating funds since the BoJ introduced its new monetary-easing measures in April.
| Japanese investors repatriate funds |
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However, MoF data does show that Japan’s ultra-loose loose monetary policy stance has been successful in engendering one source of yen weakness: encouraging foreign inflows into Japanese stocks.
Yet as the chart below shows, those inflows stalled in the past few weeks as volatility picked up, a move that sent USDJPY lower accordingly.
| Foreigners keep the faith in Abenomics |
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Gareth Berry, strategist at UBS, says a sense of proportion is needed, given that the outflows in May, at just under ¥260 billion, represent just 16% of the inflows in the first two weeks of the month.
He says for foreign investors, if the asset price effect of Japan’s new easing programme is anywhere near what the Fed achieved with its QE in the past few years, there is no reason to exit the market anytime soon, especially with currency hedging still relatively cheap.
“As such, sustained foreign buying remains the main source of support for yen downside for now,” says Berry.
Given the price action during the last 24 hours, it might take some time for the FX market to regain its composure. However, once some sense of order is restored, and if Japanese investors lose their misgivings over investing abroad, the yen could have further to fall.