Goldman Sachs estimates that Japan still has enough capacity to intervene in the foreign exchange market to support the yen several more times, following the historic intervention in July. Japan holds around $1 trillion in US dollar reserves and can also access the Federal Reserve's FIMA Repo Facility to add liquidity for such operations. Karen Fishman, a strategist at Goldman Sachs Research, said that of Japan's roughly $1 trillion in dollar reserves, about $200 billion is in cash or cash equivalents, close to the amount that may have been used in the July intervention. Goldman Sachs therefore assesses that Japan has enough ready funds to carry out yen-buying operations on a similar scale about two more times, even though in practice Tokyo is unlikely to use all of that money. Japan and the United States intervened jointly in late July after the yen weakened toward 164 per dollar, near its lowest level in four decades, marking the first time since 1998 that the US joined Japan to support the yen. In the first two days of the July operation, Japan may have spent as much as $85 billion, making it the largest two-day currency intervention in Japan's history, excluding the action in October 2011 after the Fukushima disaster. After the intervention, the yen strengthened through its 200-day moving average around 158 per dollar, but that strength has begun to fade. The yen has recently weakened back toward the key level of 160 per dollar and has given back about half of its intervention gains. Fishman views currency intervention as not a sustainable solution, but merely a way to buy time. Previously, after Japan intervened unilaterally in April and May, the yen returned to a 40-year low within a few months. However, the possibility that Japan will intervene again is making investors more cautious, especially as the yen weakens toward 160 per dollar, because the options market still reflects concern that the yen could strengthen suddenly if the authorities act. A key factor in determining whether Japan needs to intervene again is the interest rate differential between the United States and Japan, which remains a major driver of the exchange rate. The 10-year US Treasury yield stands at about 4.690%, while the 10-year Japanese government bond yield is at 2.839%, meaning US assets still offer higher returns and give investors an incentive to hold dollars rather than yen. The market currently prices about a 65% probability that the Bank of Japan will raise rates by 0.25% in September, with total policy tightening of about 0.40% expected by the end of the year. Goldman Sachs warns that if the Bank of Japan does not raise rates as the market expects in September, it could put further downward pressure on the yen and increase the likelihood that the Japanese government will have to return to intervention. In addition, the Bank of Japan may need to raise rates faster than the market expects if it wants to shift the incentive created by the yield differential, which has been a key factor behind the yen's roughly 45% depreciation over the past five years. Another important variable is the United States. If economic data come in weaker than expected, that could reduce pressure on the Federal Reserve to raise rates further and help narrow the interest rate differential between the two countries, which would be positive for the yen. The latest data show that the US consumer price index rose 0.1% in July from the previous month, in line with market expectations, while annual inflation slowed to 3.4% from 3.5% in June, causing US Treasury yields to fall after the release. Still, Goldman Sachs believes that if US economic data or Bank of Japan policy actions diverge from market expectations, investors may increase their expectations that Japan and the United States will intervene again, especially if the yen weakens back through the key level around 160 per dollar.
Goldman Sachs Group IncGoldman Sachs research cited on Japan's FX intervention capacity; no direct impact on Goldman's business.
