G-7 Coordinates Intervention to Push the Yen Lower

The Bank of Japan got tired of the yen (JPY) setting record highs, and enlisted the help of the G7 to intervene in the currency markets and push the yen lower. This is the first time the Group of Seven nations have jointly intervened in the markets in more than a decade. The result of this concerted effort was a drop of over 3% for the yen, which had touched a record high early yesterday at 76.36 yen/dollar. And the G7 finance ministers stand ready for more intervention if needed. A statement by the G7 said “in response to recent movements in the exchange rate of the yen associated with the tragic events in Japan, and at the request of the Japanese authorities” it will intervene in the currency market today. The statement went on to say, “We will monitor exchange markets closely and will cooperate as appropriate.”

We have seen the Bank of Japan try and intervene on their own in the past, with not much lasting effect. But this coordinated intervention should have a much better chance of working as the quick appreciation of the yen was, in my opinion, going to be temporary anyway. In fact, the Japanese government seems worried about the intervention working too well. Vice Finance Minister Fumihiko Igarashi said the government wants to avert any “abrupt weakening” in the currency. He acknowledged the earthquake had damaged the fiscal situation and threatened the economy so it wouldn’t be a surprise if the yen weakens further and bond yields begin to rise. “That’s naturally the biggest fear for the government.”

The intervention not only weakened the yen, it also gave investors the green light to put some ‘risk trades’ back on. Carry trades, where investors purchase higher yielding currencies after borrowing and selling ones with lower yields, were the ‘trade of the day.’ Investors boosted the New Zealand dollar (NZD), Australian dollar (AUD), and South African rand (ZAR) over 1.3% versus the US dollar and over 4.5% versus the yen. The other big winners in overnight markets were the Swedish krona (SEK) and Norwegian krone (NOK).

The Swedish krona was actually the best performing currency in the past 24 hours versus the US dollar, as Central Bank Deputy Governor Svante Oeberg suggested that interest rates in Sweden would continue to rise. Oeberg has been a vocal critic of the expansionary monetary policy and has argued in favor of raising the repo rate at every central bank meeting this year. “Even after five rate increases since July, policy can’t yet be deemed ‘tight’,” he said in a speech published this morning. “If inflation becomes higher than we had expected, it may be necessary to raise the repo rate to a normal level of around 4 percent as soon as next year,” Oeberg said. This is a dramatic change, as the repo rate currently stands at just 1.5%. The recent data seems to back Oeberg up. Headline inflation exceeded the Riksbank’s 2% target for a third consecutive month in February as commodity price increases helped push inflation up. “The inflationary risks are primarily on the upside,” Oeberg said. “If inflation increases more than is expected, it is, in my view, likely that the repo rate will need to be raised more quickly than predicted in the repo-rate path.” A more aggressive rate increase path by the Riksbank is certain to push the Swedish krona higher.

Elsewhere in Europe, UK consumer confidence fell to a record low in February as higher oil prices helped make Brits more pessimistic about the sustainability of the economic recovery. The UK economy shrank in the fourth quarter of 2010 while inflation has soared to over double the BOE’s 2% target. But despite inflationary pressures, traders are reducing their bets that the BOE will raise interest rates at their upcoming meetings. One country that has been taking an aggressive stance against inflation is India. The Reserve Bank of India yesterday raised its inflation forecast for a second time this year as it moved the benchmark repurchase rate by a quarter point, the eighth move in a year. Inflationary pressures will continue to push India’s central bank to keep rates on the rise.

As I alluded to above, the G-7 intervention gave investors confidence to return to their ‘risk’ trades. With risk back on, the commodities also began to rally, oil is back above $102 and gold and silver have rallied. Higher oil prices have helped the Canadian dollar (CAD) gain the most in a month versus the US dollar, snapping a 3-day decline. The Bank of Canada participated in the intervention, selling Japanese yen from its reserves, which also helped to push the loonie higher. A report released this morning in Canada illustrates how dramatically different the Canadian economy is compared to the US. Canadian bankruptcies fell 13% compared to a year ago, a number that illustrates the Canadian consumer is in a much better position than those in the US where bankruptcies continue to climb.

The recently elected officials in Brazil have been struggling to find a way to cap gains on the Brazilian real (BRL). International investors have been attracted by the high interest rates in the fast growing economy. Officials had discussed the possibility of placing reserve requirements on foreign investors similar to those placed by Thailand a couple of years back. But the latest stories from Brazil suggest the government is now leaning toward raising taxes to curb fixed-income inflows. The government is said to be considering reinstating a tax on bond sales overseas by Brazilian companies as well as a tax increase on foreign purchases of local bonds. These new taxes shouldn’t have any impact on WorldMarket products, as they are not taxable by the foreign government; but they could have a negative impact on the currency as fixed income investors shed their holdings.

China’s Premier Wen Jiabao has set taming inflation as the nation’s top economic priority this year. Oil price increases have combined with rising food costs to drive consumer prices in China up by 4.9% in February. Producer prices jumped an even larger 7.2% last month, the most since September 2008. The Premier realizes that large price increases throughout mainland China could ignite social unrest, and is going to do everything he can to keep inflation at bay. Overnight, China announced an increase in the reserve requirements for banks, the third increase this year. Inflation has topped the government’s 4% target in each of the past 5 months, prompting the additional moves by the People’s Bank of China. China still has some room to raise interest rates, as their benchmark rate is the lowest in BRIC nations as Brazil, Russia, and India all have rates more than double those in China.

There is no data due to be released this morning, but we had plenty to deal with yesterday. The CPI numbers here in the US showed inflation is ticking up slightly higher than forecast with the YOY number increasing 2.1% in February. Reader’s know neither Chuck nor I put much faith in this number, as prices are rising much faster here in the ‘real world.’ The weekly jobless claims showed that the labor market continues to struggle here in the US with initial jobless claims of 385,000. Continuing claims were down slightly at 3,706,000 as more workers fell off the unemployment roles. Industrial production for the month of February was the big surprise, falling 0.1% compared with an expected 0.6% increase. While the decrease isn’t large, it is still a sign that the US economy is struggling to pull itself out of the downturn. Capacity utilization, which is closely watched by all of us on the desk, fell slightly in February to 76.3% compared to an adjusted 76.4% the month prior. Another indication that the US economic recovery is weak. Finally, the US leading indicators, which are supposed to show the future direction of the US economy were just barely up at 0.8%.

Recap: G-7 intervention drives the yen lower and pushes the carry currencies higher. The Swedish krona was the biggest gainer as their central bank looks to accelerate interest rate increases. UK consumer confidence falls as higher oil prices worry consumers, and India’s central bank is also worried by the higher prices. Brazil is now considering raising taxes on foreign bond investments in order to stem their currency gains. China increased reserve requirements, and the US data illustrates our economy may be stuck in a rut.

Chris Gaffney
for The Daily Reckoning