Dollar Today

The US dollar's broad pullback is obscuring two otherwise noteworthy developments in Japan. First, both the prime minister and the finance minister made a none-too-thinly veiled threat of foreign exchange intervention.

Although one investment house was quoted on the wires late yesterday suggesting the odds of intervention stood at 47%, we suspect this verbal outburst is part of the on-going battle between the MOF and BOJ. Even though the latter may take another step this month or next to combat deflation, the MOF wants more action.

As we have suggested one of the possible actions is to simply increase the JPY10 trillion 3-month financing facility launched at the end of last year and that has nearly been exhausted. The government could order intervention if it so decided and that was the message the government was sending. The fact of the matter is that 3-month implied dollar-yen volatility is today at its lowest level since the Lehman collapse.

The three-month risk reversals, which are a gauge of the market's bias toward dollar-yen calls or puts, is the smallest since early 2007. Lastly we have acknowledged that the new budget includes an increase in financing bills, which are used to raise intervention funds.

However, the JPY5 trillion increase is modest compared with the existing authority for another JPY30 trillion before hitting the current cap. The real obstacle to intervention has not been material capability but political will. With the trade surplus growing and exports growing and the yen volatility steadily declining for the better part of the past two months, intervention threats are best understood within the context of Japanese domestic debate and not an international signal.