Recent FX intervention was unusual

The Japanese government’s recent yen intervention deviated from the historical norm in two key respects. First, when Japan intervened in the past, it typically did so repeatedly over several consecutive days. This time, however, its initial intervention on 22 September was not followed by additional yen purchases, at least not in large enough size to be detectable, until 21 October despite substantial yen depreciation in the interim.

Second, Japanese authorities have declined to confirm or deny whether they have intervened again since 22 September. Officially undisclosed FX intervention is called covert intervention. It aims to prevent unwelcome exchange rate movements by sowing fear in the market through concealment of what the authorities are up to.

If, for example, the yen were to abruptly strengthen sharply in the space of a few hours, market participants would be relieved to learn the move was due to official intervention. Intervention that strengthens the yen against the dollar presents a golden opportunity for yen bears/dollar bulls to sell yen for dollars. If disclosed, such intervention could unleash a torrent of yen selling that leaves the yen even weaker against the dollar than before the intervention.

However, if the Japanese government does not disclose that it has intervened to prop up the yen, market participants do not know if the yen’s resultant appreciation is attributable to intervention or some other unknown factor. Faced with such uncertainty, they would be hesitant to press yen short positions. Such hesitancy may be sufficient to halt the yen’s depreciation trend. This is the benefit of covert intervention. However, when intervention is so large that it is obviously intervention, like the 21 October event, the benefit of covert intervention is lost. Yet Japanese authorities still refuse to admit they have intervened on the 21st. In this respect, the 21 October intervention distinctly differs from previous covert interventions. It is unclear why the Japanese government has not publicly acknowledged the latest intervention. I surmise the reason is that Japan is acting alone without the approval of other countries, particularly the US.

Yellen not apprised of latest intervention

Bloomberg reported on 24 October that US Treasury Secretary Janet Yellen told reporters she was “not aware of any intervention that the Japanese have done.” She added, “They did inform us previously of an intervention, which we understood was a concern over volatility.”

So the Japanese government apparently informed the US Department of the Treasury in advance about its 22 September FX intervention but not its 21 October intervention even though the latter took place in the US market. Japan thus did not outsource the 21 October intervention to US authorities, contrary to the normal protocol for conducting FX intervention in foreign markets. Direct FX intervention in a foreign market is not only highly unusual, it entails operational challenges also. US authorities presumably frown upon direct foreign intervention in US markets without advance notice.

Advanced countries are generally opposed to FX intervention

Following Japan’s 22 September FX intervention, a US Treasury Department spokesperson said, “We understand Japan’s action.” While the US did not criticize the intervention, the spokesperson’s comment conveyed a hint of disapproval.

While Japan informed the US in advance of its 22 September intervention, it may have acted before the US had fully given its blessing. This possibility is corroborated by Japanese Finance Minister Shunichi Suzuki’s vague statement that “the US understands Japan’s currency intervention” before G7 finance ministers and central bankers met in Washington in October. With mild tensions around FX intervention lingering between Japan and the US since 22 September, Japan’s decision to intervene in the US market without prior notice may have hurt its relations with US authorities.

Advanced countries are generally opposed to FX intervention based on a belief that exchange rates should be determined by markets and artificial intervention distorts market mechanisms and has adverse repercussions. Another reason that advanced countries eschew FX intervention is to set an example for EM countries, some of which habitually intervene in FX markets.

Japan committed to abiding by spirit of G7 agreement

The statement issued by G7 finance ministers and central bankers at the conclusion of their October meeting in Washington included a reaffirmation of their “exchange rate commitments elaborated in May 2017,” the text of which says, “We reaffirm our existing G7 exchange rate commitments to market determined exchange rates and to consult closely in regard to actions in foreign exchange markets....We underscore the importance of all countries refraining from competitive devaluation. We reiterate that excess volatility and disorderly movements in exchange rates can have adverse implications for economic and financial stability.” The G7 does not sanction FX intervention except to curb “excess volatility and disorderly movements in exchange rates.”

Heavily constrained, anomalous FX intervention

With Japanese intervening in the FX market without the full approval of the US and other countries, it will likely seek to avoid further criticism and international tensions by stressing that it is abiding by the May 2017 G7 agreement. Even if Japan actually wants to halt the yen depreciation trend that is fueling domestic inflation, it is firmly committed to keeping quiet about this preference and strictly limiting its FX intervention to curbing “excess volatility and disorderly movements in exchange rates.” It consequently may be able to intervene in the FX market only when the yen is rapidly weakening, not during periods of gradual but persistent yen depreciation.

Meanwhile, without the cooperation of overseas authorities, Japan will have difficulty conducting FX intervention in overseas markets even when exchange rate volatility spikes. In deference to US opposition to FX intervention, Japan will likely refrain from immediately disclosing its interventions and consequently end up intervening covertly.

With Japan engaged in FX intervention against the wishes of the US and perhaps other countries, its interventions are subject to multiple constraints. These constraints will likely result in FX intervention that is not only anomalous but also less effective than usual.

• Takahide Kiuchi

  Executive Economist