Dear CIGAs,

Bank of Japan Intervention Soon?

That is the big question weighing on the minds of currency traders. The initial knee jerk move higher in the Yen, due mainly to repatriation of funds by Japanese companies and citizens to the mainland, can explain the rally in the Yen during the early part of this crisis. However what now appears to be happening is a potential unwind of the Yen carry trade which has been blowing up due to the massive move away from risk. The price action in the Yen compared to the price action of the US equity markets is evidence that many hedge funds were borrowing Yen and then using the cheap money to leverage up on US stocks. While the carry trade using this particular currency is nowhere near the size it was back in 2008, it is still very large. Back in 2008 when the credit crisis erupted in the US and spread around the globe, the Yen staged an enormous rally.

Hedge funds, which had acquired massive leveraged positions using the Yen as the funding currency, commenced a headlong rush to the exits en masse. In effect they had acquired a massive short Yen position which the Japanese monetary authorities were more than happy to condone. When the Yen began moving higher, suddenly the trade began souring as gains in the leveraged positions were being dragged underwater by losses on the currency front due to gains in the funding currency. As commodities and stocks were sold off, the trade because to collapse. Their panic to deleverage forced the Yen sharply higher even as the stock markets and commodity markets were obliterated to the downside.

Once again we can see what appears to be an exact repeat of late 2008. Given the fact that the Japanese economy has been devastated by recent events, the last thing that the Japanese monetary authorities want to see is a soaring yen, which will effectively cut off their export markets at the knees by hurting their price competitiveness on the global markets.

What we might see begin to happen is the BOJ coming in and beating the fire out of the speculators by selling enormous amounts of Yen on the foreign exchange markets this evening or very soon. One wonders what they might do with all the US Dollars that such action would accumulate in their coffers. In the past they would sterilize the intervention effort by purchasing US Treasuries.

If that were to happen this time around, the Fed could sit back and watch the BOJ do its QE work for it.

Again, this situation is very fluid and can turn on a dime but it is highly unlikely that the BOJ and the Japanese Ministry of Finance are not keenly watching what the hedge funds are doing to its currency.

The difference between what happened to commodities and other assets in 2008 was that the Fed was not engaging in any form of QE at the inception of the crisis. It could well be that we now have QE3 set in stone.

Click chart to enlarge in PDF format with commentary from Trader Dan Norcini

For further market analysis and commentary, please see Trader Dan’s website at www.traderdan.net