The US and Japan were acting out a fairly well choreographed dance at the G7. To take account of voters at home, the US has to appear to be tough on currency manipulation and to maintain pressure on the real target of its concern: China.
Japan, meanwhile, can only keep the option on the table, as ruling it out might cause the yen to appreciate even further. But just having it as an option might be enough to prevent having to use it.
This balancing act led Japanese finance minister Taro Aso to declare that yen moves are “one-sided, speculative and disorderly”. His definition of disorderly stipulates that FX moves of “five yen [against the dollar in either direction] over two days are considered one-way and lopsided”, something Bloomberg reports has occurred 51 times since the start of 2000.
US Treasury secretary Jack Lew countered that yen moves have not been significant enough to be called “disorderly”, setting a higher bar for the term. G7 countries refused to commit themselves to intervention in the foreign exchange markets to limit the yen’s movement, while Aso has played down the chance of a unified G7 approach to boosting demand through fiscal, monetary and structural measures.
Yet this apparent disunity belies a greater level of mutual understanding that exists between G7 members. Paresh Upadhyaya, director of currency strategy at Pioneer Investments in Boston, says: “Japan is one of America's most stable and predictable allies. So while the US might be firm on currency manipulation in public, privately it will handle this situation with considerable discretion.”
In one of the three benchmarks cited in the US Treasury Report concerning whether a country is a currency manipulator, it says a country should not make net purchases of currency worth more than 2% of GDP. That would suggest Japan could make purchases of up to $90 billion without overstepping the US guideline – a substantial arsenal.
Upadhyaya says: “If a country like Japan or China so much as calls around a few banks asking for prices it can move markets. If the BoJ wanted to intervene, even relatively modest purchases of $10 million here and there, maybe no more than $100 million in all, would be enough to achieve its goal.”
The row will keep flaring up whenever the Japanese currency is strong or strengthening, as it is now. General risk aversion, partly linked to Federal Reserve rate increase expectations, has led the yen to trade up in recent days since the G7 meeting.
The Bank of Tokyo Mitsubishi UFJ says: “Less favourable financial market conditions are acting as a dampener on the ability for USD/JPY to take part in the broad-based US dollar rebound. External conditions of weak global growth still remain supportive as well for the yen.”
Joel Kruger, FX strategist at LMAX Exchange, says: “As much as the yen appears fundamentally overvalued at current levels, the currency has yet to successfully break away from its correlation with risk off flow. US equities are now looking like they could be on the verge of rolling over, and if this plays out, we shouldn’t rule out the possibility of a resurgence in yen demand, with USD/JPY potentially retesting and breaking down below the recent 105.55 multi-month low."
There are bets that Japan will realize its goal of a weaker yen without the need for intervention. This is partly driven by the fact that many of the factors conspiring to strengthen the currency have eased in recent weeks. There had been big concerns about the outlook for global growth earlier in the year, but these have eased to some extent. Commodities had been in free fall, but there has been something of a resurgence here too. Both factors ease safe-haven flows.
This helps alleviate perhaps the biggest concern of all: that the Federal Reserve might tighten policy further and faster than expected. Yet these concerns have also subsided. Even fears about Brexit are less acute than they were, weeks before the vote, as many in the market feel an out vote has now been priced in.
There is also a feeling that Japan has ways out of its current predicament that do not entail outright currency purchases. Rumours have also been swirling of a possible snap election, with the disorganization and unpopularity of the opposition giving prime minister Shinzo Abe the option of attempting to renew his mandate to push through a package of measures – perhaps some financial reforms combined with additional infrastructure spending – to revive the economy.
This would be welcome in a country that faces a weak export outlook and a gradually increasing oil price that is likely to slow momentum in its improving trade-balance numbers. Its seasonally adjusted trade surplus widened to ¥427 billion ($3.9 billion) from ¥95 billion in April.
There has also been some confusion about the government's position on the raising of the consumption tax. The governor of the Bank of Japan, Haruhiko Kuroda, has acknowledged the impact the last such hike had on the economy, which was more considerable than forecast. This fed hopes that the government might delay the tax increase. Yet Aso has sown confusion by describing it as unavoidable.
Upadhyaya says: “Japan really needs to resolve that uncertainty around the consumption tax hike; it affects sentiment and has huge ramifications for the economy. The government needs to be decisive in ruling out an imminent hike.”
Between certainty over the consumption tax and fiscal measures adopted by the government, many are confident direct currency intervention will not be necessary. What is expected is an announcement on further monetary easing in at least one of its upcoming meetings.
Upadhyaya says: “The BoJ just needs to find a way to ease without damaging its banks, which risks undermining the Nikkei, which risks leading to yen strengthening – the opposite of its intention. It needs to prove to markets it has no constraints in its QE purchases, perhaps by buying more equity ETFs. It needs more than just a negative interest rate policy.”
However, if other measures fail, few doubt the Bank of Japan would act – especially considering that the wording of the US guidelines against intervention give it cover. The question is at what level it would feel compelled to act.
Yujiro Goto, senior FX strategist at Nomura, says: “100 is the really psychologically important level for traders and policymakers [compared with ¥109 per dollar currently]. But Aso has voiced concern about volatility and he would
want to step in before it got to that level. That is why I think traders will start getting cautious around the 105 level.”