BOJ Joins SNB To Intervene Aggressively

BBH CurrencyView

• BOJ intervenes aggressively to weaken yen; we do not see any major G7 initiative
• Euro zone periphery remains under pressure as ECB meets; Spain borrowing costs rise
• Global equity markets are lower as growth risks, sovereign risks persist; EM FX softer too

BOJ intervention on the heels of action by the SNB rattled currency markets, shaking off many of safe haven positions. As a result, today we have the unusual combination of global equity markets lower by around 0.75% but USD/JPY up 3.6% and USD/CHF up 1%. EUR/USD is slightly lower to 1.4250, around the middle of its roughly 1.40-1.45 range which has held over the last several months. Major fixed income markets are quiet and periphery yields are mixed, rising 18 bp in Greece but falling 12 bp in Spain at the 10-year sector. Energy prices are over 1% lower, with Brent crude falling for the 5th consecutive session to $90.85/barrel, a level not seen since late June. Gold is little changed at 1664 $/oz. EM FX largely weaker, led by Turkey’s wrong-headed decision to cut rates.

BOJ joints SNB in fighting currency strength. Aggressive intervention during the Asian session drove USD/JPY over 80. However, both BOJ and SNB actions are unlikely to have much lasting impact on their currencies as long as global safe haven flows persist. BOJ ended its 2-day policy meeting, and while it left the policy rate at 0.1%, the bank raised asset purchases from JPY10 trln to JPY15 trln, the first such action since March in the aftermath of the Sendai earthquake and tsunami. The last time BOJ intervened, the Fed acted during the North American session and bought dollar/yen as well. However, the amount was quite small that day, only $1 bln. Other G7 central banks also intervened in token amounts, supporting the view that it was not any sort of major multilateral initiative. We think that holds true today, and that BOJ (and SNB) will be largely left to their own devices. G7 was probably more open to helping BOJ in March since the Japan earthquake posed a big unknown risk to the world, and destabilizing FX moves like the flash crash then were undesirable. Recent yen strength has been slow and steady, and we would argue that BOJ intervention will perversely end up boosting FX vols. Both the Fed and ECB have bigger fish to fry at the moment. Indeed, problems on both sides of the Atlantic are the main drivers behind safe haven flows into the yen and Swiss franc. Until those are addressed, those flows will continue and JPY and CHF gains should resume. BOJ and SNB can lean against the wind, but we see little chance of them reversing those moves.

BOE keeps policy steady, all eyes are now on the ECB. No ECB hike is expected, and so markets will watch the press conference later for clues on future policy. Given the backdrop, Trichet is unlikely to signal any sort of rate hike in September with his coded language. It is possible that he signals potential use of the SMP bond-buying program, which has lain dormant for the last 18 weeks. As it is, that would only provide temporary relief. Furthermore, the ECB may be reluctant to do this again, as rising borrowing costs is a major factor in getting faster action from the politicians to take action to stem the crisis. Also, with Spain and Italy bond markets much larger, the ECB may be hesitant to lend support to those two as the potential amounts needed to stabilize those sovereign bond markets would likely be much larger than what was needed for Greece, Italy, and Portugal. Spain auction went OK but borrowing costs still rising. Spain sold EUR2.2 bln bonds due 2014 at an average yield of 4.813% vs. 4.291% in July, and sold EUR1.1 bln bonds due 2015 bonds at 4.984%. Total was slightly below the maximum set at EUR3.5 bln. Until the policy-makers can come up with a game-changer (which the EU summit did not produce), we see the debt dynamics continue to worsen and draw in the larger peripheral countries. Belgian and French yields have crept higher as well in recent weeks.

The Turkish central bank further confused markets in its unscheduled meeting today, leading USD/TRY back towards its recent high of 1.7347 from late July. The bank cut the benchmark rate by 50bps to 5.75% and increased the borrowing rate from 1.5% to 5%, thereby narrowing the corridor. The bank also announced that it stands ready to sell dollars from its roughly $92 bln stock of reserves to defend the lira in an ad hoc fashion starting tomorrow. In short, the bank is reacting to signs of moderating domestic growth (though GDP up 11% y/y in Q1) and expected weakness in external demand (though exports/GDP is just 17.5%). We think Governor Basci is playing a very dangerous game. The lira is already 25% weaker from the November 2010 highs and with the trend likely to continue, it could start to trigger heavy USD buying by locals. The monthly current account deficit is around $7.2 bln and currency weakness will only increase Turkey’s large energy import bill.