Yen, Tamed

The comment yesterday, from the Japanese Economics Minister, Akira Amari, that the yen exchange rate was now “ in line with fundamentals”, and the market’s quick back-up reaction, got me a laugh, and has me thinking. Have things changed so much? Or is this just an illusion?

It was not long ago that we had the complete reverse of what we have today. Prior to 2009, markets were the dominate forces that determined the outcome of “things”. Government leaders and finance officials have been talking for decades, they never got markets to “behave” as they wanted to before. That’s completely changed. At least that appears to be the case.

As an example, consider what Mario Draghi accomplished last summer by merely mentioning the word “unlimited”. The markets immediately bowed to the new, all powerful, Deity. Those markets are still in subservient mode, yet Draghi never really did a thing, except talk. The underlying problems in the EU are worse today than last summer, but the financial crisis has functionally disappeared.

As far as the efficacy of Central Bank currency intervention is concerned, one need look no farther than the utter failure of the BOJ to contain the appreciate of the yen over three decades. It tried to talk the market up, it intervened again and again, but the yen continued to rise. For many years, the market conclusion was that the more the BOJ bought - the more the market would demand.

My observation:

The BOJ was on the defense all those years, it was never on offense. A central bank that gives up the offense to the market, creates a situation where the market will exploit the weakness in an attempt to make a profit.

Note: The Bank of England’s big losses in the 90′s to the FX market, as well the endless money that was made from 1970 through 2011 at the expense of the Swiss National Bank, are other example of CBs that were on the defense, and fed the “kitty” for the markets.

Where ever you look around the globe today you see evidence that the monetary authorities have achieved the offensive. They have complete control of both the direction and volatility of markets. The best evidence of this dominance is Bernanke’s magic of setting the return on tens of trillions of dollars of long term securities at rates that will produce a negative return against inflation. There can be no other conclusion, but that the US capital market has folded its cards, and Bernanke has won. At least for now.

This takes us back to Mr. Amari’s comments yesterday. He thinks that now that we have had a back up in the yen crosses, the FX markets should just go to sleep, and trade in narrow ranges. As of now, the markets are again bowing and scraping to this type of talk.

It could turn out differently. It might just be that those finance types in Tokyo have unleashed some very powerful forces. These forces will not get contained by talk that things are now “balanced”. Two factors:

- The market is very well aware of the fact that BOJ WILL NOT stop additional yen depreciation by reverse intervention (at least not for the next 10 big figures). This reality sets up an asymmetrical risk situation. There is no “lid” on USD/JPY.
- The “market” has made a true fortune on the short side of the yen trade the past six months. This “made” a few big firms' year. This set-up ALWAYS leads the market players, who now have a big pile of chips in front of them thanks to the “house”, to press on with the betting.

We have in front of us what might prove to be the first test of the new found “dominance” of the CBs and the talkers. I think it’s likely that USD/JPY moves up another 10%. That could happen pretty quickly. There is nothing in the way, and the argument that an FX rate is now “fair”, is irrelevant. The simple fact is, there is money to be made on the short side. It’s just a question of timing.

In the immediate future there is a real question for the dollar. What’s going to happen with the debt limit and related issues? Will America shoot itself in the foot? With that in the air, the USD/JPY, and the yen crosses, might take a breather for a spell. But I think it will prove to be a pause in the action.

The yen is going to get cheaper. Cheaper than the Japanese want. Cheaper than America wants. Cheaper than the EU, China and the BRICs want.

When that happens, it will be fair to ask:

“Are those talkers and CB’s really in charge? Or was that just a phase we passed through?”

And if so,

“Who’s next?”