On Friday, the Group of Seven (G-7) pledged once again to combine all their mighty powers to launch a coordinated currency intervention to stabilize the yen. After all, the chance of success of a joint intervention is much much greater than just the Bank of Japan (BOJ).
The Bank of Japan also promised that they would continue to engage in aggressive monetary easing to ensure that the country does not plunge back into recession.
There had been already rumors that the G-7 would intervene prior the actual announcement, yet the G-7’s move still had a huge impact on the forex market. Within minutes after the announcement, USD/JPY came off its all-time lows at around the 78.00 region and soared just a couple of pips shy the 82.00 handle.
The last time the G-7 intervened in the currency market was more than a decade ago. At that time, EUR/USD was sitting at its all time lows at .8257 (No, that’s not a typo) and had lost almost a third of its value since its inception.
The world powers decided to take action because the euro’s weakness threatened economic stability. For one thing, the weak euro caused inflationary pressures to increase to unwanted levels.
The falling value of the euro also made goods manufactured outside euro zone more expensive, which hurt the import sector. Remember, whenever a local company wishes to import something from abroad, they must first convert their currency to the currency of the country they wish to import from.
Let’s say you live in Los Angeles and wanted to buy an authentic Japanese samurai sword. You decided to check the “Samurais R US” website based in Japan and saw that the current price is 8,100 yen.
If the exchange rate was 81.00 yen for every dollar, then the sword would cost you 100 dollars. But what if the dollar became weaker and every dollar only amounted to 75.00 yen? The purchase would then cost 108 dollars (8,100 / 75)! Now, multiply the additional cost by a bajillion units… and you’ve got a very big problem in your hands.
Within a day after the world’s coordinated effort to buy the euro, the currency jumped 4% against the dollar. From then on, the euro was able to stage a major rally, ending the year millennium more than a thousand pips higher at .9426. A success, you think? I certainly think so.
If history is said to repeat itself, then we can expect that the G-7’s currency intervention effort to work wonderfully. The question now is… how high will they take USD/JPY?
According to Japanese export companies, they need USD/JPY to reach 86.30 or weaker to keep them profitable. While this is just a rough estimate, it gives me an idea of what the BOJ is possibly aiming for.
Whether the 86.30 target can be reached or not remains to be seen. I believe there is just too much uncertainty right now, and with nuclear meltdown fears far from over, the chance of risk aversion hitting the foreign exchange market again still very present.
Be careful out there.