The Last Look…

One of the big topics in the FX market at the moment is the increasingly agitated response of Japan to the weakening yen – barely a day goes by without one or other Ministry of Finance spokesperson saying they are prepared to act or are watching developments closely, but if the MoF does tell the Bank of Japan to intervene, will it do so in accordance with the FX Global Code?

As a small digression, I suspect those wondering on the timing of the intervention need to pay attention to the noise levels out of Tokyo – if it goes quiet from the MoF, then that’s probably the day!

Anyway, as someone who is too old school for his own good, I always enjoyed a good central bank intervention – not least because when it is against the fundamentals of the situation as it is with USD/JPY, currently (it’s called “carry” MoF!) it provides a great opportunity to buy cheap dollars. Assuming that is, there are still traders left in the world who can do so…

I raise the question of the Code because a friend of mine brought this up last week, noting that back in the day, central banks of all hues used to intervene by lining up the market makers and hitting them all at the same time. If you want an indication of how well that went, ask the (very) old person on the desk about Black Friday, when the USD/DEM (you can ask them about that as well kids) did something like 40 big figures (up and down) in the space of an hour or two, with the Bundesbank selling at the top and the world buying the dip.

The critical phrase in the FX Global Code cited by my friend is in Principle 9, market participants “should not enter into transactions with the intention of disrupting the market”. We can, naturally, have a broader discussion about whether intervention knocking USD/JPY down five big figures in a matter of minutes (seconds probably) is “disruptive”, but can probably agree it’s not exactly calming things down!

The answer to the question posed by my friend comes down to how the BoJ intervenes. There are many different ways for a central bank to hit the market – some of which are perfectly fine and within the Code’s guidelines, others that take us into grey areas.

First and foremost, the BoJ can give EBS’ volumes a boost by going on and placing a large order on the primary venue for all to see. The algos at the market makers will all see it and price accordingly and we will have a dip. The problem is, it probably won’t be deep enough or quick enough to satisfy the Japanese authorities, (although I suppose they can always go again at lower levels). There is nothing wrong with this as far as the Code is concerned, but would it achieve the desired result, which is, let’s face it, market disruption (for the longs anyway)?

Another way is just to smack (technical dealing term) the ECNs left, right and centre, and watch the carnage unfold. This, I would argue, is disruptive, and would be in breach of the Code, because it is tantamount to machine gunning the market and trading with the intention of creating upheaval.

A third way also raises ethical issues – what if the BoJ gives orders to multiple banks to sell at the same time? These participants are not going to hang onto the dollars, therefore will all hit the ECNs, probably simultaneously, which, again, disrupts the market, and this is where it gets doubly tricky.

These players have accepted an order that they know will create instability for a period of time, so what should they do, given it’s from, originally, the Ministry of Finance, their gubernatorial authority (and not a signatory to the Code). I refer readers to the earlier quote from Principle 9.

I think lining up banks the way it used to happen is now off the table, but there is also the option of giving the order to just one bank, so where would this sit? On one hand, It’s hard to see how an “at best” order for a couple of yards is breaching the Code, but on the other, it would still disrupt the market – because, to reiterate – that is the intention. And the Code is all about “intent”.

There are some who would argue Japan will intervene just to smack a few speculators over the wrist, and that is against the spirit of the Code – because it is trading to deliberately hurt other participants

It is an interesting question as to whether any LPs hurt by intervention will see such an act as undermining the Code and question why they adhere? On which note, even though I dislike the practice, it would be funny to see the BoJ’s reaction if it was rejected on last look!

In the last rounds of intervention in 2022, the BoJ sold in excess of $60 billion, which actually surprises me a little, but is also heartening, because it shows it’s still difficult to intervene even though most LPs just churn risk these days, which would suggest it would take a lot less to actually get the market lower.

Obviously, policy decisions mean it is totally within Japan’s rights to intervene, so perhaps the question is, as noted earlier, how does it do it? A sub-theme is whether the policy decision is right; are moves “excessive” to use a favourite word of the authorities there? There are some who would argue Japan will intervene just to smack a few speculators over the wrist (with six month points over 400, longer term longs won’t be badly hurt), and that is against the spirit of the Code – trading to deliberately hurt other participants.

If volatility was higher than it currently is then perhaps one could understand Japan’s desire to intervene, but the fact is, it isn’t. Vol remains low, (perversely, one thing that would see it jump is BoJ intervention!) and as long as that is the case, it is fair to argue that Japan’s authorities would be in breach of the Code if they intervened to create disruptive conditions.

At the end of the day I suspect, they care less about whether they intervene in the “right” way – all they want is a higher yen, but nevertheless, it might be worth keeping a close eye on the offer for a few days…

colin@thefullfx.com