It’s been a busy day so far for central bankers, especially in Japan and the US. As we noted on Monday, the yen has seen massive safe haven / carry trade unwinding flows over the last two weeks, and as a result, USD/JPY is now falling for its 7th consecutive day to a new 15-month low under the 115.00 level.
Unfortunately for the Bank of Japan, the last thing the Japanese economy needs is a strengthening currency driving down inflation and exports further. Things have gotten so bad for the BOJ that some traders are speculating that the central bank will soon intervene in the market by selling yen in an effort to push down the value of the currency.
For the uninitiated, there are essentially three "levels" of central banker intervention in the FX market, each sending a stronger signal than the last:
1) Verbal Intervention: The first level, and one that we’ve seen repeatedly across the globe over the last few years, is verbal intervention or "jawboning." This is when a central banker makes vague comments about how the relevant currency is "overvalued" and that depreciation of the would be "appropriate."
The BOJ has engaged in heavy verbal intervention over the last few weeks, with top-tier financial policymakers calling the recent yen moves "rough" and noting that they’re "watchful for speculative moves" in the yen.
2) Rate Checks: Rate checks, or "call arounds" are when a central bank actually calls FX dealers to see what the current exchange rates are, with the implication that its considering selling its own currency. To use a geopolitical analogy, this step is similar to the military drills that some country’s occasionally conduct in a show of force.
Though its difficult to pin down exactly if and when a central bank conducts a rate check, there were unconfirmed reports that the BOJ was on the phone calling dealers when USD/JPY dipped to 114.25 in today’s Asian session.
3) Market Intervention: Of course, the final level of intervention is when the central bank places actual orders in the market in an effort to drive down its currency’s value (in other words, when the central bank actually acts on its rate checks).
The Bank of Japan established a pattern of repeated intervention as the yen continued to strengthen throughout 2010 and 2011, though the BOJ hasn’t actively intervened in the currency market since then. If USD/JPY continues to fall, many analysts expect that the BOJ will have nochoice but to act.
Against the backdrop of increasing concern with the yen-strength side of the equation, USD/JPY traders also had to grapple with the implications of Fed Chair Janet Yellen’s semiannual Humphrey-Hawkins testimony to congress. The Q&A portion of the presentation will begin shortly after we go to press, but the pre-released prepared remarks came off as relatively dovish, roughly in-line with market expectations. Yellen noted that "financial conditions in the United States have recently become less supportive of growth" and that "if the economy were to disappoint, a lower path of the federal funds rate would be appropriate," essentially confirming that the Fed is concerned about the recent market developments.
For the most part, USD/JPY traders took Yellen’s prepared remarks mostly in stride, with the pair merely edging down from about 115.00 to 114.60. That said, if the Q&A portion of Yellen’s speech suggests that the Fed is unlikely to raise rates in the first half of the year (a development traders have already priced in), USD/JPY could press against this week’s trough in the lower 114.00s, potentially forcing the BOJ to intervene later this week or month.