The big story in the past week was the massive currency intervention by the Bank of Japan (BOJ). Hard to know exactly how much went through, but reports were in the range of $70bn on Friday alone. FX interventions by major central banks are less frequent than they were years ago. This was the first BOJ buy side intervention since 1998. There is a pretty simple reason we don’t see intervention much anymore – it does not work. Let’s have a quick look at what’s going on.
Against the trend of most other central banks, BOJ policy has been to maintain low interest rates and keep long term yields under 25bps (a policy called yield curve control, YCC), despite rising inflation and a global backdrop of major economy yields rising substantially. They have been the principal buyer of Japanese Bonds, leading to a crash in liquidity. In recent weeks we have seen multi day streaks when the benchmark 10 year bond (the JGB as its known) has not traded. Forcing long term interest rates to below market levels (the 10y swap market has rates around 70bps) has created massive pressure on the currency, and the BOJ has tried to stem the tide.
Intervention is like trying to hold 100 ping pong balls underwater at the same time – sooner or later one will pop up. As long as the BOJ keeps interest rates artificially low and continues yield curve control, the currency will eventually, intervention or not, get blasted. When the Fed is guiding market yields close to 5% and even the Europeans are raising 75bps a meeting, the policy gaps are untenable. Something has to give. As we write this, the BOJ is intervening again – they moved the currency about 1 percent, and then it immediately sold off again.
So why is the BOJ doing this. Japan is by far the most indebted major economy. That was fine as long as rates were low. What changes that calculus is – you guessed it – inflation. Unwinding these policies is like landing a jumbo jet on a football field. As the now ex UK PM Truss found out, the room for maneuver can shrink pretty quick.