USD/JPY downside risk towards 111… intervention threshold lowered from 111 to 110
The Japanese yen (JPY) broke below the 112 level earlier today as the weak US dollar trend post FOMC continues. This has increased the risk that a retracement towards this year’s low of 111 will materialise sooner than later. In February we had a view that the Japan Ministry of Finance (MoF) is likely to intervene when USD/JPY heads lower towards 111 due to sharp volatility in the JPY and pace of gains in the JPY nominal effective exchange rate (NEER). However we now think that the risk of intervention has declined for the following reasons. Though the JPY nominal effective exchange rate has strengthened by about 1% since the beginning of this week, current JPY NEER levels are still about 2% lower than the peak in February. This reflects a broad US dollar weakness. Hence a 2% appreciation in the JPY NEER could imply a USDJPY rate closer to 110 than 111. In addition realized volatility (1 week) in the JPY is still about 40% below the peak of last month. Volatility expectations has also moved lower with 1 week breakeven downside rate of just below 111. In short, the risk of intervention as prices head towards 111 has declined. Stop losses are expected to be layered below 111 and hence could exacerbate price action towards 110 sharply. As speculators’ long positions are overcrowded and volatility is expected to rise further if 111 is breached, we do not rule out intervention by the MoF around the 110 level.