How the BOJ’s Forex Market Intervention Will Impact US Investors
On Thursday, in a move that was quite nostalgic for an old forex guy like me, the Bank of Japan (BOJ) intervened in the forex market. They bought their own currency in the open market in an attempt to prop it up, after dollar/yen (USD/JPY) broke through the 145 level that marked a high few weeks ago.
If you are unfamiliar with forex, I should explain here that in a currency pair, the quoted rate represents the strength of the first named currency against the second; in this case, the dollar against the yen. Thus, higher USD/JPY means a weaker yen. Weak enough yesterday, in fact, that the BOJ started to sell USD/JPY, their first market intervention since 1998.
As I said, nostalgic for me, but that isn’t relevant to most people. It does, however, raise two questions that are. Can the BOJ succeed in reversing the tide of the market, and what will be the potential impact of their attempt on global markets and U.S. investors, whether they do succeed or not?
The simple answer to the first question is no, they cannot succeed. I don’t want to disillusion Masato Kanda, Japan’s top currency official, but if the market wants USD/JPY higher, it will go higher, no matter what he or the BOJ say or do. That is a statement based not on the arrogance for which forex market participants were once famous, but on history and simple logic.
Central bank intervention has been out of favor since the 90s because that was the decade when central banks around the world finally realized that it was really no more than pointless saber rattling, doomed to have nasty consequences when it failed. They know that because in 1992, the Bank of England, after two years of trying to keep the pound (GBP) in an artificially created range against the deutschmark (DEM) and other pre-euro currencies, finally conceded defeat on September 16, 1992.
That day has become known as “Black Wednesday,” and I was there, working on one of the busiest GBP/DEM desks in the world. I remember the shock, then fear, and then the sense of foreboding that came when I heard the words “I don’t pay” coming from the Bank of England, after weeks of them being on the bid to defend the pound as the market tested and probed. And I remember the sense of exhilaration as it dawned on me that the market of which I was a small part had taken on the “Old Lady”, which alongside the Fed was the ultimate power and authority in global finance at that time, and we had won. We, a bunch of loud-mouthed kids, had broken the Bank of England!
We were able to do that, not because we were smart or skillful, but because the forex market, when united, was simply too big for anything to control. George Soros later took “credit” for breaking the bank, but insiders saw that as a smart marketing ploy more than anything. It was a concerted effort, with just about every trader building massive short positions over time in the correct belief that the Bank couldn’t keep buying forever.
Now factor in that the global forex market back then was around $1 trillion a day and had grown to $6.6 trillion by 2019. Then allow for the flood of global liquidity since the pandemic, and you can start to see that if the forex market as a whole decides that USD/JPY is going higher, it is going higher.
But, as they showed yesterday, the Bank of Japan will fight that unwinnable fight anyway. Maybe it is just pride that has led them to do that, or maybe they believe that if they can make traders pause, they will rethink and decide that even though the BOJ is not increasing interest rates as the Fed and most other central banks continue to do so, the yen is still an attractive asset to hold. The evidence so far is inconclusive as to the effects of the intervention, but the signs are somewhat ominous.
USD/JPY fell of a cliff yesterday, which is hardly surprising. This generation of traders have never seen central bank intervention, and when you first confront it, I can tell you from personal experience it is awe-inspiring. But, today, there are already signs of a bounce back, and human nature being what it is, that 145 level is now a target and a challenge. At the very least, a retest, with a lot more buying power behind it, looks likely before too long. When it comes, the BOJ will presumably sell again, but their continued selling of ever-increasing amounts of dollars must eventually have an impact.
Unlike the Fed, the BOJ can’t just create dollars out of thin air to sell. They have to have a positive balance in their USD account in order to do so. At some point, if the market sees the BOJ’s actions as a challenge, that balance will run low, and the BOJ will have to liquidate some assets. To put it another way, before too long, there will be a massive seller of treasuries in a market that has already seen massive selling in response to the Fed rate hikes. That will push yields even higher, increasing the relative value of the dollar over the yen, encouraging more USD/JPY buying and forcing the BOJ to sell more dollars, liquidate more treasuries and force U.S. rates even higher.
It is a vicious cycle from which the only exit involves an admission of defeat from the BOJ, but which in the meantime will force U.S. rates even higher, increasing the chance of recession here and forcing stocks even lower.
It doesn’t have to end that way. Traders could change their minds and decide that they don’t want the easy money from the carry trade that the interest rate differential between the two countries creates. Or the Japanese Ministry of Finance and the BOJ could swallow their pride and admit their ineffectiveness in the face of the weight of over $6.6 trillion per day. Neither of those is likely to happen quickly though, so the BOJ’s intervention is probably going to be yet another thing putting pressure on stocks over the next few weeks and months.
The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.