The Last Look…

Far be it for me to give a national authority some feedback on its activities, but on the basis it has never stopped me before, why break the habit of a lifetime – let’s talk Bank of Japan intervention.

I am sure I am not alone in sighing whenever I hear the “warning” that volatility is unwarranted or moves excessive, from Ministry of Finance speakers. For a start the “volatility” they talk about is any move they don’t like the direction of, and are moves excessive when USD/JPY has moved something like 4% since January?

The problem for the MoF speakers is that their complaints too often lack credibility because they over-dramatise things – it is the boy who cried wolf to a degree, and while these are sometimes politicians, the bureaucrats should know better. The result of this over-dramatisation is a market that pays attention to one thing – flow. Unless and until the BoJ intervenes the FX market largely ignores the running commentary, and USD/JPY continues to rise on interest rate differentials, and the machines price and trade accordingly.

I have spoken to a couple of friends of mine who, like me, are of a (ahem) “certain vintage”, and we all agree – things are just too predictable. When it comes to really important things like monetary policy, we all benefit from rational, stable, clear-thinking central banks, but once again FX is a little different. If you want to shock the FX market you have to be unpredictable – it is something that builds a grudging respect at least, because one thing investors and directional traders fear is uncertainty. This is why, I suspect, the latest bout has had a longer lasting effect – because the market was surprised by the US following up with selling of its own.

Back in the day (here we go I hear you groan…) probably the most feared central bank was the Bundesbank (this is pre-euro I should stress), and often it was because it could carry a big stick and hit the market hard. Sometimes it was in unison with other central banks (more on that in a second), which gave it greater weight, but often it just came out of the blue, and, frankly, stuffed people! We all knew it might happen because of the levels the market was at (high and low), but very little was said publicly – Buba et al let the money do the talking.

On that note, and a small digression, I remember there was one European central bank that clearly didn’t have the heart to really get involved – while Buba and its other friends were selling boatloads, this CB would call up two local banks, give or take 10 bucks from each and sign off with “this is intervention”!

I suspect Buba knew something that some modern-day authorities need to learn – the FX market can’t be controlled, but it can be intimidated. Ask the SNB about trying to control the FX market, it works…until it doesn’t.

Maybe, rather than talking a lot, and occasionally hitting the market, perhaps the BoJ needs to be a more frequent participant, using different tactics

So what should Japan do? Well talking publicly and endlessly about “undesired” moves does nothing, nor, it seems, does one big slap once every few months. My friends and I were thinking it should become more unpredictable, rather than, to use the latest example, lobbing 52 yards into the market in one hit, maybe 10 yards would get things going, and then, when people think they have finished, give them another 10. To a degree, this has happened with the US follow up – it will be interesting to see how the market goes this week.

The whole strategy is about hurting those who disagree with them – in this case the buyers. Let them buy it back and get long at 159, but at 160, hit it to 157. In other words, inflict repeated pain in smaller doses. This also, of course, introduces a degree of nervousness among carry traders and investors, which would slow things down. The problem at the moment is just about everyone sees intervention as an opportunity to buy cheap dollars.

Of course, there is still the problem of a decent carry for all those Japanese retail investors, and until that changes, the MoF is fighting a losing battle, but that, one day, may change, so until then, maybe, rather than talking a lot, and occasionally hitting the market, perhaps the BoJ needs to be a more frequent participant, using different tactics (time of day, size, etc). The extra swat given to the market by the US seems to have worked, so that could be a lesson for the MoF in Japan going forward.

I suspect the US’ involvement is the real differentiator here, but that is not to say that in future, when it likely goes back to acting on its own, that Japan, rather than following the current playbook, cannot confuse everyone. They might find it is more effective, because in a quant, data-certain world, the one thing (nearly) guaranteed to help you out, would be the creation of confusion and uncertainty.

colin@thefullfx.com