USD Versus JPY: Will There Be A Co-ordinated Intervention From G-10?

USD: Following Dubai World's debt moratorium, global markets came under heavy pressure. US banking stocks were set for heavy falls on Friday, as the market opened after a holiday and experienced the first chance to factor in the prices. Global banks have already written off $1.7 trillion since the start of the crisis and raised $1.5 trillion. According to Chris Turner of ING Wholesale Banking, with Dubai's total loans outstanding at $80 billion, markets are poised to witness reversal in the recovery trend.

EUR: AUD/USD has been the best pick and ING expects a move to 0.88/89. USD is stronger across the board as investors book profits in popular trades. This year’s EUR/USD rally had been dominated by buy-and-hold reserve managers and ING expects demand coming in back at 1.47/48. It expects strong Swedish Q3 GDP numbers, owing to strong housing sector and expectations of an early Riksbank hike. EUR/SEK looks a sell at medium term and GBP/USD should find support at 1.62/63.

EM: After witnessing an excellent year in the emerging markets, investors are running to the sidelines. USD/Asia ex Japan is rallying hard and even short term gold trend has reversed. Emerging markets dominated the fund flows this year, amid concerns over credit growth in EMEA. This could suggest under performance of Asia in the current spell and that more flexible pairs, such as USD/KRW could spike back to the 1200 area.

JPY: On Thursday, USD/JPY crashed below its previous low for the year at 87.10. Key drivers were: a) increase in risk aversion following the Dubai World debt restructuring, which hit the bank stocks badly, and b) fall in the US interest rates, where three month USD LIBOR is now at 0.25%.

Defying expectations, Japan's Ministry of Finance had ruled out unilateral intervention, citing this as a dollar led move. The Ministry had said that it will consider intervention only if USD/JPY fall below 85. There are some background factors that have been helping JPY. In April this year, Bank of Japan introduced tax break for repatriated foreign dividends; this witnessed substantial increase in repatriation. Bank of Japan (BOJ) has stated that large companies are fully funded already and there is concern about small businesses.

Japanese economy has been witnessing deflation and intense competition from fellow Asian exporters, but the new DPJ government didn't bother to express any concern. Their complacence can be attributed to two factors:

a) Real JPY TWI is still some 40% off the highs seen in 1995

b) DPJ argues for a consumer oriented economy

The crux of the issue is however dollar, not the JPY. Back in April 1995, US treasury adopted a change of stance, introducing strong dollar policy at the same time Fed was increasing rates. The turn-around in FX policy was reported in the G7 statement of April 1995, calling for orderly reversal of dollar weakness. It was delivered through co-ordinated intervention and consistent monetary policy, including a rate cut of 75bp by the BoJ.

However, it is unlikely that US will repeat its action this time. The primary reasons are that the US wants a weak dollar to restore its credit growth and import prices are still relatively low. Also, the dollar decline has not been disorderly, which is generally associated with higher equity markets and narrower credit spreads.

ING expects that co-ordinated intervention will not take place as long as USD/JPY and EUR/USD are above 80 and 1.60 respectively and US authorities feel there is value in coordinated action. It expects that USD/JPY will retest the low 80s seen in 1995.