Exchange-rate policies produce the usual spiral of interventionism: the de facto consequences tend to diverge from the original intentions, prompting further rounds of doomed interventions. This interventionist escalation is not only limited to an incessant repetition of the same failed policies, but the errors committed in one policy area also affect other parts of the economy. Thus, it is only a matter of time until errors of monetary policy lead to fiscal fiascos, and exchange-rate interventions lead to trade conflicts.- Dr. Antony P. Mueller
The markets loudly cheered on Japan’s aggressive engagement of her version of quantitative easing. Even more ecstatically to the joint intervention by the G-7 on the currency market to weaken the Japanese Yen.
As I earlier pointed out, there is little relevance between Japan’s money printing and the containment of the radiation risk[1], as well as, the weakening of the Yen which may, on the contrary, even harm the recovery process, as a weak currency would increase the prices of imports which Japan sorely needs for her public works[2].
Yet this is exactly what I have been driving about since time immemorial, the global financial markets addiction to inflationism.
It’s not clear how effective such interventions work. The last time Japan intervened massively in the currency markets in 2004 (£150 billion[3]) as shown in the above chart[4] the result was an apparent failure.
To add, this week’s market meltdown, despite manifesting some signs of 2008 or across the board selloff, lacked the traditional safehaven features: the US dollar (USD) hardly rallied (red circle below the YEN) while the rally in US treasuries (UST) had likewise been unimpressive!
Meanwhile the Euro (XEU) substantially firmed while the Yen (XJY) soared by 3.3% on Wednesday March 16th! But the Yen gave up much of its gains on Friday following the G-7 announcement.
Reports say that the repatriation trade has been exaggerated.
According to the Finance Asia[5],
Japanese insurers are well-hedged at about 70% and have huge holdings in government bonds, which they could easily sell if they needed yen. And the industry is reinsured by the government anyway, so there is no shortage of yen in the insurance market.
The repatriation trade is, at best, premature, but the rumour of its existence was enough eventually to tip the market into a forced sell-off yesterday as dollar/yen sank below 80.
Mrs Watanabe, the archetypal Japanese housewife, typically holds a long position in US dollars. By Tuesday, those positions reached an all-time peak and, with dollar/yen parked close to 80, foreign speculators anticipating repatriation flows started to sell in the early hours of yesterday morning as trading moved from New York to Tokyo and liquidity was exceptionally low.
It is unclear if these reports are accurate and dependable, but it would seem that the steep overnight climb of the Yen has been unwarranted.
And thus, the markets natural response has been to sell down the Yen down which apparently has been exacerbated by the G-7 intervention.
Furthermore, critical credit markets hardly budged.
US Cash indices and 3M Libor OIS spread for both the US and the Euro, had seen little signs of anxiety in the face of the meltdown.
All these simply evince of a knee jerk fear premium.
In addition, the European Financial Stability Facility [EFSF] has been reinvigorated which may have given some legs to the Euro. According to the Danske Bank research team[6],
The negative events seem to have overshadowed the positive news that EU leaders agreed on new terms for the EFSF. The lending capacity of the existing facilities has been increased to EUR500bn and the EFSF has been allowed to purchase bonds in the primary market. This could prove a substantial help for Portugal. In addition, the interest rate has been lowered for Greece and the maturity extended after Greece agreed to sell state owned assets worth EUR50bn. The moves by the EU leaders were ahead of market expectations and are positive for peripheral spreads and therefore for the banking sector.
The actions of the Euro have basically been fulfilling what we have been saying throughout 2010[7].
Bottom line:
The current environment has clearly departed from the 2008 episode.
Moreover, like Pavlov’s dogs, financial markets have been elated by inflationism, which only means that current market trends can continue if governments continued to inflate.
[1] See Japan’s Disaster Recovery Program: Wishing Away Real Problems With A Tsunami of Money, March 15, 2011
[2] See Currency Intervention: Japan And The G-7 Aims To Boost Stock Markets, March 18, 2011
[3] Businss TimesOnline.co.uk Japan ends its £150bn currency intervention as economy firms, March 24, 2004
[4] Shedlock Mish Currency Intervention Madness, Japan Intervenes to Weaken the Yen, September 15, 2010
[5] Finance Asia, Mrs Watanabe, not repatriation, driving yen volatility, March 18, 2011
[6] Danske Bank, Weekly Credit Update, March 18, 2011
[7] See Ireland’s Woes Won’t Stop The Global Inflation Shindig, November 22, 2010; See Buy The Peso And The Phisix On Prospects Of A Euro Rally, June 14, 2010
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