I was on the Business News Network this morning talking about today’s developments including the Japanese elections, the prospect of intervention, the UK CPI numbers, the reason why euro is weak and U.S. retail sales. Click on the image to access the Video
Last week we raised the question of what the Swiss National Bank is waiting for and why they haven’t intervened. In that article we said “Everyone has an uncle point and for the SNB there is no question that we are nearing that level…” At that time, EUR/CHF was trading at 1.4272 and apparently today’s record low of 1.4144 was all the SNB could handle!
They have denied to comment on the move in the Swiss Franc but a 265 pip rally EUR/CHF in under 6 minutes is exactly the type of move that only occurs when there is intervention. Most likely, the SNB had their buy orders sitting were right below 1.4150. Judging from the price action in EUR/CHF after interventions last year, the rally will probably not last particularly since the central bank is talking about raising interest rates.
For the eighth trading day in a row, EUR/CHF has failed to rally. The Swiss Franc even ended the day at a fresh record high against the euro as traders test the resolve of the Swiss National Bank. This has led many currency traders to wonder What is the SNB Waiting For? Why haven’t they intervened?
The problem is that even though the central bank has been warning about intervention, they have also been talking about raising interest rates. Over the past year, a lot of traders have sold Swiss Francs as a funding currency because of its low yield and now the prospect of a rate hike will force them to unwind their short CHF positions. Although intervention risk is exceptionally high at this time, the reason why the SNB has not intervened yet is because we are in a very different place now than in March 2009.
When the global financial crisis hit, there was a tremendous amount of deleveraging in which investors bought back Francs and closed their positions. Many Swiss banks also reduced their balance sheets, leading to downside pressure on EUR/CHF. In fact, net capital flow into Switzerland hit a record high last year. As a result, EUR/CHF fell aggressively at a time when the financial crisis was still unfolding, forcing the SNB to step into the market to weaken the Franc. The central bank intervened 3 times last year from what I can tell – in March, June and September. Since then, the global economy has stabilized, Switzerland came out of recession and the economy is improving.
With less to fear, the SNB has remained out of the market opting for verbal versus physical intervention. The trade surplus is a lot higher than last year and exports remain at healthy levels, reducing the need for intervention. Forex traders love to test the resolve of a central bank and I continue to expect them to do so until the SNB actually steps in. Everyone has an uncle point and for the SNB there is no question that we are nearing that level but as we have seen in the recent price action, betting on a move by the central bank can require deep pockets.
Last Friday, the CFTC released their weekly report of futures positioning. According to the data, which was as of last Tuesday, short positions in the Japanese Yen hit the highest levels since August 2008. At that time, the Yen weakened significantly and soon after a short squeeze pushed the currency sharply higher against the U.S. dollar.
The following chart illustrates the strong relationship between Yen positions and the JPY/USD (the inverse of USD/JPY). Right now the Yen is rising against the dollar despite the fact that traders are substantially short Japanese Yen. This means that should the Yen continue to rise, or in other words USD/JPY continues to fall, there could be an aggressive short squeeze that triggers a big move higher in the Yen and a sharp breakdown in USD/JPY.
A further rally in the Yen will undoubtedly test the resolve of Japan’s Ministry of Finance and at some point, maybe below 87, the Japanese government may feel compelled to step in and vocally criticize foreign exchange fluctuations but until then, the odds are skewed towards further losses in USD/JPY.
USD/JPY hit a 13 year low of 88.22 today after news that the bailout plan is not going happen before the new year. If you have been following my blog, I called for a move down to a new 13 year low Wednesday morning. At that time, USD/JPY was trading at 92.50-93.00. The currency pair has reversed violently after falling to 88.22.
Will the Bank of Japan Intervene?
A big question on everyone’s mind is Will the Bank of Japan intervene. Don’t expect BoJ intervention to happen anytime soon. As an export dependent nation, a strong currency is not in Japan’s best interest. However unlike in the past where the BoJ has intervened when USD/JPY fell below 105 and 100, we may not see any action by the Japanese government this time around. Since the problems are inherent in the US and the Eurozone, intervening at this time may be counterproductive for the Japanese. The only type of intervention that has ever worked is coordinated intervention. The BoJ will have a very tough time convincing the Americans to take any steps that would lead to further strength in the US dollar. The Japanese government needs to stand aside and allow the US and Eurozone governments to take their measures to spur growth and not strengthen the dollar for their own short term relief.
USD/JPY Chart from 12.10.08