Did the Fed Simply Pass the Printing Baton to the Bank of Japan?

Yesterday, rumors fueled an early equities rally on speculation that the FOMC would announce next Tuesday a new round of Treasury purchases--the long awaited QE 2.0--in no small part to the statement we quoted from Morgan Stanley in our discussion of the same subject. The theory being: this would be the Fed's last chance to accommodate during the historically perilous September/October time frame for the stock market, and also not wanting to be seen as influencing the November mid-term election (the next announcement would actually occur the day after the election on November 3). Regardless, MS has relegated its stock-goosing hypothesis to a low probability event. Yet overnight, the Bank of Japan, as agent for the Minister of Finance, took printing matters into its own hands. From Goldman Sack's Fiona Lake:

In the last phase of Japanese intervention running from early 2003 to March 16th 2004, the Japanese intervened on 129 of those days, accumulating Yen36.3trn-worth of reserves in the process. The most persistent phase of intervention was in late 2003, beginning of 2004 and the largest one day Yen selling January 9th 2004 of JPY1.6trn. Over that period, the Japanese initially defended the 116 area, before stepping away in late September, in the run-up to the Dubai G7 meeting and ‘smoothing’ the cross down to 105-106. This level was subsequently defended heavily. The BoJ/MoF will provide aggregate data on the size of today’s intervention and any subsequent intervention on the last business day on the month. Detailed daily intervention data typically becomes available on a quarterly basis.

On the assumption that the volatility around the DPJ election result yesterday was a key trigger for intervention today, it is quite possible that the Japanese authorities will intervene again in response to similar circumstances and it is indeed possible that we see more intervention in the next few days. Broadly speaking, the administration likely want to introduce more two-way risk in USD/JPY in order to stem further speculatively Yen appreciation vs the USD or on a TWI basis. Despite intervention today, we would not rule out notable new lows in $/JPY at this stage. Importantly, the political environment is unlikely to tolerate persistent Japanese intervention given the broader political pressures to allow Asian FX appreciation.

BoJ Governor Shirakawa commented that he hopes MoF action will stabilise FX rates and that the BoJ will continue to supply ample liquidity to the markets and pursue strong monetary easing. This suggests that the BoJ are not in a rush to mop up the liquidity provided by today’s intervention. As a reminder, in an emergency meeting on August 30th the BoJ announced it would start providing 6-month term funding of approximately JPY10trn.

If this is, in fact, only the beginning of a sustained intervention with no attempt at sterilization, the Bank of Japan may simply be picking up the global liquidity slack now that its own election is over while the Fed awaits the end of mid-terms to tag back into the printing ring. Though it's true the BoJ removed US Dollars in an amount equal to the Yen it sold at the prevailing exchange rate, there is nothing that constrains it from sheltering those Dollars. It could lend them to its banks (Nomura's also a primary dealer), purchase US Treasurys or use them to buy any other number of Dollar denominated assets. The BoJ has even been known to buy equities held on its member banks' books (its most recent stock buying program ended in April, 2010, which coincidentally top ticked the US equities rally).

Accordingly, it's instructive to review the prior BoJ intervention period from 2003 through March, 2004, which was also concurrent with extreme Federal Reserve accommodation.

Click for larger image.

While there are, of course, many other variables at play, the image is startling. (Incidentally, this too was a period when the BoJ purchased equities.) Given the apparent failure of the prior intervention (the Yen actually strengthened 10.8%), one wonders if the goal was as much to make Japanese exports cheaper as it was to salvage a principal market for its exports--that is to save the US economy by conspiring with the Fed to kick off the next bubble.

As RW at EPJ Central noted earlier, there were big currency movements underway even before the intervention, with the US Dollar sliding big against the Euro and actually reaching parity with the Swiss Franc. With Yen strength so prevalent as of late, it could simply be a last ditch attempt to preserve the carry trade. Regardless, we'll look with keen interest in the days and weeks ahead as this potential source of back-door QE develops.