Is a spike in currency volatility about to happen?

>> Is BoJ ready for currency intervention?

If you look at a chart of dollar/yen it seems to be flatlining just below the 152 level. The last two-and-a-half weeks have seen dollar/yen seemingly trapped between 151 and 152. That’s an incredibly narrow range for dollar/yen and all because the FX market appears very bullish for the dollar but the BoJ is thought to lurk above 152 with a hefty dose of FX intervention at the ready.

This situation reminds us of an official currency peg or band; not a market that is supposed to be flexible. For instance, in the days of the old Exchange Rate Mechanism, in Europe, where currencies traded in fixed bands, normally with a width of 2.25% or 6%, a currency devaluation would be preceded by this sort of flatlining of the currency at the lower bound. This left the central bank with a choice; to either let the currency go, or to push short-term rates up significantly and/or intervene to try to bludgeon the market into submission. Most often, devaluation was the only way out. Moreover, when the devaluation occurred it was usually large; dictated by the fact that permitting a modest devaluation would just entice the market to attack the new lower limit .

But dollar/yen is not in any sort of fixed currency system. The 152 level has not been defended by the BoJ. For when it conducted its only recent intervention back in September 2022 it did so from levels far below 152. Hence there is no official line in the sand and the BoJ would do well not to try to put one there because this could entice even more pressure from the dollar bulls. Instead, the 152 level exists because it has broadly been the top of the dollar/yen range in October of 2022 and again around a year later.

Nonetheless, it still presents the BoJ with a big problem and one that, perhaps unfortunately, it has made worse by upping the intervention warnings when dollar/yen has neared the 152 level. Hence, for all intents and purposes the 152 level does, indeed, seem to be acting like the top of a pre-defined and official trading band for dollar/yen.

The last set of data on the positioning of speculators by the CFTC would seem to suggest that, far from being scared about intervention from the BoJ on the other side of 152, traders have increased their short-yen positions. The net short-yen position stood at over 143k contracts in the latest week, the biggest yen short since 2007. That’s more than two-and-a-half times the size of the short-yen position at the start of the year.

>> Central bank meetings and impacts on currency market

As things stand right now we clearly have a standoff at 152 between FX traders that seem to be holding very substantial short-yen positions, and a Bank of Japan that has huge currency reserves (USD1.15tr). Is it possible that the large size of these arsenals keeps dollar/yen locked at 152, or is something likely to give? We suspect that something will give as the dollar/yen bulls force a break of 152 which is then followed at some point by BoJ intervention to try to repel the attack.

We can’t say for sure how far the dollar bulls will be able to go beyond 152 or how much success the BoJ will have in pushing the dollar back down again, but what does seem very likely in our view is that there will be a spike in volatility as this plays out. A bigger question is whether any increase in volatility in dollar/yen infects volatility elsewhere as other currencies start to mimic the yen’s ups and downs against the dollar. This is possible as the September 2022 intervention did seem to bring about dollar weakness, not just against the yen, but against other currencies as well.

In the end, our money is on the BoJ being victorious, but that’s not likely before the dollar bulls have had their day with a manoeuvre that takes dollar/yen temporarily above 152.