Konnichiwa!

Thats Japanese for "Hello" or "Good afternoon"

This week's news belonged to the land of the rising sun. The Bank of Japan did what it had been scaring the markets about for the first time in 6 years.

The BoJ, followed the Bank of China and intervened the currency markets selling an estimated Yen 2 trillion ($23 billion) on two consecutive days as the currency reached a low of 82.88 vs. the USD. As a result the yen depreciated over the last week closing near 85.8 vs. the dollar.

Rationale for intervention

Reasons for the intervention are largely quoted as protection of the country's exports after the currency has seen large appreciation over the past few months primarily due to China increasing its holding of the Yen in an attempt to diversify away from the dollar. The move accentuated by some safe haven flows.

The Political Angle

The intervention took place the very next day after Prime Minister Nato Kan had won the challenge thrown at him by opponent Ichiro Ozawa who had claimed currency intervention if brought to power. By this move, PM Kan showed in a way that he too "can" take decisive action against the "threat" seen on Japanese exports.

Possible Impacts

Currency intervention by a G7 country is a pact with the devil. Especially when it is not supported by other major central banks. Moreover, this makes it extremely difficult for the US to negotiate a stronger remnibi with China, who can now just take the Japanese example as a point for protest. Moreover it is not quite clear if currency appreciation will really make a large difference to exports from Japan as up until now Japanese exporters have pretty much been 'reaping' money.

In any case the future actions of Japan is worth to keeping an eye on. My guess is even though it may not seem very logical or "purely" political, its not easy to prove that Japan is not serious about intervention. The last time the BoJ intervened was a multiple set of actions lasting 15 months starting June 2003. Who's to say thats not whats going to happen again!

Let's try to make some money!

View: Long on the Japanese yen with some constraints

Rationale: Fundamental factors like China increasing yen holdings, flight to safety flows, momentum in the currency. Currency intervention being the constraints.

Product: Call option on the Yen with strike at 86 and knock-out at 82.

Product Rationale:

1. Long position on yen through the call option

2. Knock-out at 82 makes the option expire if USDJPY goes below 82. This significantly cheapens the option premium as we forfeit all upside beyond yen appreciating over 82.

Macro Support

1. Official talk of currency target threshold of USDJPY at 82. "We will not permit precipitous moves in the yen", said the Finance Minister.

2. The last time BoJ intervened, it lasted 15 months with multiple interventions from June 2003 to September 2004.

3. Political pressure from Ozawa likely to continue.

4. General tendency of the yen to appreciate

Fed Talk

For every meeting from now till the economic data shows significant upside, the FOMC will be facing the same question. Do we act now? Do we hold off?

The next meeting is due on September 21, 2010 and the Fed is most likely going to be inclined to wait. One suspects that the tone of the Fed would become slightly dimmer. But the likelihood of it embarking on a new round of quantitative easing as was hinted by Bernanke in his speech at Jackson Hole, seems dim. Even with dismal Home sale numbers and revised Q2 GDP of 1.6% (from 2.4% previously), the hurdle required for Bernanke to make such a move is absent.

There has been little to suggest a significant deterioration since then: private sector payrolls rose by 67,000 in August and manufacturers made positive noises in the most recent Institute of Supply Management survey. Given the Jackson Hole signal, to make a big move in September would risk confusion in the markets.

There is also a strong suspicion that the latest growth number overstates the weakness of the economy. An apparent surge in oil imports alone subtracted more than one percentage point from growth in the second quarter in spite of little sign that the US was actually consuming more oil.

It does not follow, however, that the FOMC will continue to sit on its hands as long as the data do not get any worse. The committee’s outlook is that growth will accelerate to 3 or 4 per cent in 2011 – well above its long-run trend. Any sign that the economy is not speeding up again in the coming months would be a “significant deterioration” to many FOMC members, prompting action.

A reason to act immediately would be a further loss of market confidence in the outlook for growth and inflation but Mr Bernanke’s Jackson Hole speech seems to have had a soothing effect.

There is one other argument in favour of a September move, although Fed officials insist that it is irrelevant. The Fed’s subsequent meeting ends on November 3 – the day after midterm elections in which the Democrats might lose control of Capitol Hill – and it could be politically uncomfortable to make a big change to monetary policy the next day.

If and when the Fed does decide to ease policy, there is a fairly strong consensus on the FOMC that further quantitative easing is the way to do it.

Some form of “QE2” is likely to be one of the policy options put to the September meeting and the committee may debate the form it would take were it needed.