US and Japan intervene in FX market; largest two-day in 15 years

US and Japan intervene in FX market; largest two-day in 15 years

What the US-Japan Currency Intervention Means for the Yen, Rates, and the Dollar | Goldman Sachs

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What the US-Japan Currency Intervention Means for the Yen, Rates, and the Dollar

The scale of Japan’s intervention was historic, but the US role was symbolic. Japan’s operation, estimated to be worth up to $85 billion over July 30 and July 31, was its largest two-day intervention on record outside of October 2011. The US leg was much smaller, but pushed the yen further by signaling the US’ willingness to help.

Washington’s involvement was likely aimed at limiting volatility in US markets. The timing of US support coincided with some volatility in US interest rates, in addition to other factors.

Intervention may buy time, but it is a short-term measure. In the longer term, policy measures convincing Japanese investors to shift back towards Japanese assets could help reverse the yen’s low valuation.

The US and Japan coordinated on the biggest currency market intervention in 15 years, helping to stabilize a weakening yen. Karen Fishman, senior FX strategist in Goldman Sachs Research, and Praneet Shah, global head of FX options trading in Global Banking & Markets, discuss why the US joined the action, why the yen still appears undervalued, and whether another intervention might follow.

Allison Nathan : The United States and Japan have coordinated the largest currency market intervention in 15 years to help stabilize the yen. After more than five years of yen weakness, it’s left investors asking the question: why now?

I’m Allison Nathan, and this is Goldman Sachs Exchanges. To understand the why and the knock-on effects for currency markets, I’m sitting down with my colleague in Goldman Sachs Research, Karen Fishman, and Praneet Shah, who leads foreign exchange options trading within our Global Banking & Markets business. Praneet is joining me from London, and Karen is here with me in the studio. Karen, Praneet, welcome to the program.

Karen Fishman: Thanks for having me.

Allison Nathan: Karen, let’s first level set for the generalist. Talk us through what happened and why this is a big deal.

Karen Fishman: Yeah. So, on July 30th, Japan conducted or began its biggest intervention in the FX market in 15 years. So, they sold US dollars to buy Japanese yen in an effort to halt the weakening that we’ve seen over much of the past year, but especially over the past few months when the yen hit 40-year lows versus the US dollar. And this was a big deal for both its size and its scope. So in terms of the size, we won’t have the official numbers for another month, but we can use indirect data to get a broad sense of how big it was, so things like interdealer trading volumes and BOJ data.

And so there are a number of figures floating out there, but we’ve estimated over the first couple of days, so July 30th through July 31st, that it probably amounted to up to $85 billion, and maybe there was a bit more done on August 3rd as well, since volumes were elevated that day too.

And so to put these numbers into context that would be Japan’s biggest two-day intervention in the FX market on record outside of October 2011, which was in the aftermath of the Fukushima disaster. And then in terms of the scope, it was also coordinated with the United States, as you mentioned.

And this type of joint action hasn’t been taken also since 2011, a week after the Fukushima disaster. And actually, I think it’s worth noting that also that intervention was coordinated across the broader G7, so this is just the US and Japan, so maybe a little bit less significant from that perspective. But of course, the US’ involvement is significant nonetheless.

Allison Nathan: I want to dive into so much of that, but let’s just take a step back for one moment.

Why has the yen been so weak, for people who don’t follow it that closely?

Karen Fishman: Yeah. It’s mainly a consequence of Japan’s domestic policy mix.

The government is pushing through big spending plans, and the Bank of Japan has been hiking interest rates only very gradually over the past couple of years. Markets view that combination as inflationary, so in other words, those rate hikes are insufficient to contain the rising inflation risk. And so if inflation is rising and rates aren’t keeping up, real returns go down, and so investors move their money elsewhere or even bet against the yen, and so that’s pushed the yen weaker.

Now, it hasn’t just been the domestic policy mix that’s been weighing on the yen, its also been a function of the broader macro backdrop. And really, despite all the volatility we’ve seen at periods throughout this year around AI, oil, and Fed expectation, we haven’t really seen recession odds go up, and so you haven’t really seen that demand for safe haven assets like the yen. And also similarly strikingly, FX volatility has remained very low, and so that’s a good environment for carry trade.

So, investors have been leaning into those. So, buying higher-yielding currencies and selling lower yielding currencies like the yen.

Allison Nathan: But remind us why a weaker yen is something Japan doesn’t want.

Karen Fishman: So a weaker yen makes imports more expensive. So think higher prices at the grocery store, higher gas and electricity costs, more expensive overseas travel. All of these things weigh on households and businesses. Now it also raises government borrowing costs, which is I’m sure a focus as well.

At the same time though, it is beneficial for exporters and also tourists coming to Japan. But from a broader economy perspective, it raises the cost of living.

Allison Nathan: Right, so the case of Japan’s interest in this intervention, I think is pretty clear, as you just said. But why does the US want to be involved? What does it get from a stronger yen, a more stable yen?

Karen Fishman: Yeah. No, that’s a great question, and I would just start off by saying that volatility in one market often spills over into global markets.

So, a weaker, more volatile yen, should mean a stronger, more volatile dollar, and that can raise financial stability concerns, weigh on growth expectations, and then amplify those initial concerns, so you can kind of see how that would be an undesirable mix. But I think, really the key question has been what to make of the US’ involvement, and that’s been a bit of a debate.

On the one side, coordinated intervention often signals some alignment of policy goals, and intervention is often most effective when it signals an imminent shift in policy,

So, monetary policy expectations usually. And the Bank of Japan has signaled already its openness to a faster pace of hikes, and so markets have taken this as a reason to put higher odds or really think that it’s more likely than not that the Bank of Japan will be hiking rates again at its next meeting in September.

And I think that’s fair to some extent, but the other side of the debate is that the US’ involvement is more about maintaining the volatility or limiting the volatility in US markets. And there are really three reasons why that’s a more compelling explanation to us.

First, the US administration has been encouraging the expansion and use of the Fed’s facility that allows central banks to raise dollar cash by selling their US Treasuries to the Fed and then agreeing to buy them back later. So basically, this would be a way for Japan to avoid putting abrupt upward pressure on US interest rates by having to sell US Treasuries on the secondary market to raise that cash for intervention.

So I think that’s probably the clearest example of US market functioning being a top concern. The second reason is the timing of the US’ support for Japan. So basically, Japan has made a few efforts this year to support the currency, and it seems like the US has joined in on those efforts when there has also been upward pressure or some volatility in US interest rates.

So just to kind of quickly walk you through that, back in January, both Japan and the US signaled to the market that they might intervene, but then they ultimately didn’t. Then in April, Japan did intervene, but on its own. And then, of course, now in July, Japan intervened in big size and the US did join in. And both in January and in July, there was some more volatility in US interest rates going into those periods of action, whereas in April there wasn’t. And so I think that pattern also clearly shows that market functioning is a key consideration. And then the final one is just the scale of the intervention.

It looks to be a lot smaller, the US’ operation relative to Japan, and so also the timing of the intervention in the market wasn’t choreographed like prior coordinated interventions have been. And so it does seem to really be more about the signal of support and ultimately the US’ focus on market conditions rather than taking a strong view on where the yen should be.

Allison Nathan: Put some numbers on that for us that the US leg of this intervention was a lot small than the Japanese leg.

Karen Fishman: So we don’t have the official numbers yet. And so similarly, you can kind of rely on traded volumes and price action, and ultimately it just looked a lot smaller. And historically, coordinated interventions or the US’ participation in these coordinated interventions tends to be a lot smaller.

It’s been historically around one to two billion dollars. So again, more about the signal than actually driving the currency in a certain direction.

Allison Nathan: Praneet, let me bring you into the conversation. You were sitting on the trading floor in the middle of all this as this intervention was unfolding. What did that look like in terms of volumes and moves? Walk us through it.

Praneet Shah: Thanks, Allison. It’s useful to split it into two parts. If you first look at the MOF, which is the Japanese Ministry of Finance, they intervened on the Thursday and the Friday. Like Karen said, it’s $60 billion on a Thursday and around $25 billion on the Friday. We think there’s another $20 billion possibly on the Monday as well, and this compares to about $30 billion average daily volume traded in the market.

So it’s pretty sizable in comparison. You can also look at a second part of this. You can see how much we think actually traded in the market overall. The best way to get an idea of this is EBS, which is the main spot exchange that we look at. That typically trades around $5 to $10 billion a day. So when we look at the actual numbers that were posted on the Thursday and the Friday, it was about $90 billion on the Thursday and $80 billion on the Friday.

So even more sizable in comparison to what a usual day looks like. So you can imagine what we saw on the trading floor, I think it was one of shock and surprise. When you look at the size of the moves, 3% was the move that you saw between Thursday and Friday. That’s more or less in line with a usual episode of intervention from the MOF.

I think what took us a bit more by surprise was the subsequent 2% move thereafter once there were some signs that there was coordinated intervention with the US. I think despite the fact, as Karen just said, that the volumes actually weren’t that large from the US side, I think that symbolism to us is actually quite interesting to look at because they managed to move it 2% despite significantly less volumes compared to the $85 billion that the MOF. The last point to note is in terms of the loss of momentum, the market was really looking at this 200-day moving average in yen. We managed to breach below 158,