Japan Unlikely to Get In Yen's Way

MAY 10, 2011   THE WALL STREET JOURNAL

By ALEX FRANGOS

HONG KONG—Even as the yen continues to flirt with levels against the dollar that spark talk of more intervention to damp its rise, Japan seems likely to hold its fire.

On March 18, when the world's attention and sympathy was focused on the quake-stricken country, the Japanese government, backed by central banks from the Group of Seven, sold yen and bought dollars in a bid to reverse the currency's damaging ascent.

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Andrew Harrer/Bloomberg News

Yoshihiko Noda, Japan's finance minister, last month

This time, though, the decision is less clear-cut. Most importantly, the dollar has fallen against most currencies in recent weeks as U.S. interest rates get dragged down by fears the economy's momentum is slowing. Were Japan to seek to limit the yen's gains, it likely would be on its own, making intervention less likely to be successful.

"I wouldn't rule it out completely, but circumstances have changed," says Gareth Berry, foreign-exchange strategist for UBS in Singapore. "You could argue this is a different problem. This is about dollar weakness rather than yen strength."

The dollar was little changed against the yen Monday, trading at ¥80.74 late morning in New York, compared with ¥80.57 late Friday in New York. Late last week, the dollar dipped below ¥80, a level that traders suggested could prompt Japan to initiate another round of intervention. The level is considered important because many of the country's top employers, including auto and electronics exporters, make business planning assumptions that the dollar won't fall below that level.

Other factors have changed in the seven weeks since the Group of Seven industrialized nations banded together to weaken the Japanese currency.

While the dollar is just back above ¥80, the yen remains weaker against most other currencies, including against those of its biggest trade partners, such as the euro zone, China, and South Korea and Taiwan. Measured against a currency basket of its trade partners, the yen is almost 5% weaker than it was before the March 18 intervention. A weaker currency can make a country's goods more competitive globally and at home.

Another factor is oil, which even after last week's plunge remains substantially higher than six months ago. A stronger yen benefits Japan by giving it more buying power for oil, which is priced in dollars. Japan imports the vast majority of its energy needs.

Government officials seem to have tipped that intervention isn't imminent. Finance Minister Yoshihiko Noda said Thursday "market conditions are different from those in March." He said Friday that the government will "closely monitor" the situation. Economy Minister Koru Yosano said Friday described the situation as "not of the yen's unequaled strength but the dollar's weakness."

"The comments said in coded language 'We are OK with the dollar move so far,'" says Adarsh Sinha, foreign-exchange strategist for Bank of America Merrill Lynch in Hong Kong, who says he was surprised at how explicit the comments were.

Should Japan decide to reenter the markets, it would likely have to go it alone, rather than rely on other G-7 members. Unilateral interventions are often seen by economists as less successful over the longer term. And they will require Japan to use more monetary firepower to move markets than if they had partners at the European Central Bank and Federal Reserve.

Another deterrent: Interventions tend to work best when macroeconomic forces are already pointing in the direction of the intervention. In the weeks after the March intervention, the dollar was strengthening on hopeful U.S. economic prospects and higher U.S. bond yields And the world was at its most uncertain and pessimistic about Japan during the worst of the twin natural and nuclear disasters. The dollar rose to as high as ¥85.52 in early April.

Then things changed. U.S. bond yields starting falling amid fears of a slowdown in the U.S. recovery. The dollar-yen rate is highly correlated to differences in bond yields in the U.S. and Japan. The smaller the difference, the less incentive that investors, especially those in Japan, have to buy dollars.

"It's going to be difficult to fight a broad dollar move that's happening for a lot of reasons that are not yen-specific. If U.S. yields keep moving lower, it will be very difficult to fight the trend," says Mr. Sinha of Bank of America Merrill Lynch.

So far investors in sufficient quantities haven't pounced to drive the yen even higher against the greenback. Some are still fearful that despite the government official's soft language, an intervention could emerge and wipe out their bets. Mr. Sinha points to domestic retail investors who have been buying dollars in recent days and might have seen ¥80 as a buying opportunity.

Many are of the view the yen will weaken again, intervention or not. The dollar "could rebound to ¥85 without intervention and we believe current levels provide a good opportunity to buy," currency analysts at Nomura said in a note to clients Friday.

Write to Alex Frangos at alex.frangos@wsj.com