There is a lot of talk this morning that the Bank of Japan is checking currency rates. The Japanese Yen has continued to rise over the past 24 hours and by checking rates, the central bank is keeping a very close eye on where the Yen is trading. Given that it is almost 11pm in Japan right now on a Friday, the central bank is either very serious about intervening in the currency market or they want to keep currency traders on their toes. The 87.00 level for USD/JPY could very well be their breaking point. The risk of intervention is limiting the decline in USD/JPY on a day when the sharp drop in Dow futures should be driving it much lower. Over the past 6 months, we have seen a significant appreciation in the Japanese Yen to the point where the central bank can no longer ignore it. For example, the Yen has risen more than 40 percent against the British pound, Australian and New Zealand dollars.


Source: FX360.com

The Bank of Japan has not physically intervened in the currency market to sell the Yen since March 2004. If they intervened now it would open up the floodgates and possibly cement a bottom in the Yen crosses. Although physical intervention rarely works in the long run, many traders remember the BoJ's aggressiveness when they did intervene between 2002 and 2004. When the BoJ intervenes, we can see 200 pip movements in USD/JPY within a matter of seconds.

With the global economy slowing and the Yen rising, Japanese corporations are most likely pressuring their government, which already has ultra low approval ratings to take action. The central bank and the Ministry of Finance may no longer be able to turn a blind eye to the recent strength of the Yen that has brought the currency to the highest level in 13 years against the dollar and the highest level ever against the British pound.

US Should Take Cue from Japan

US traders should pay attention to what is going on in Japan. The rapid appreciation of the Yen played a central role in driving Toyota to its first loss in 67 years. Disappointing earnings is a major reason why the US equity market is doing so poorly. Not only are US companies losing more money than anticipated but they are warning of further losses to come. We often said that the strength of the US dollar will weigh heavily on US corporate earnings for the fourth quarter, but if the dollar does not reverse its slide in February, first quarter earnings could be even worse. More weakness in equities will drive more investors into the safety of the US dollar, the Japanese Yen and gold, which is up more than $22. This vicious cycle can continue until traders capitulate or governments step in.

But if there is no intervention, USD/JPY may not be able to keep its head above water for long.

Kathy Lien is Director of Currency Research at GFT, and runs KathyLien.com.