Thai Floods and Yen Appreciation

The dollar has slipped to almost JPY77.50, the lowest since the massive intervention last week. At today's lows, the dollar has given back almost 50% of what the intervention had achieved. It is still mind boggling the magnitude of the intervention. In one fell swoop the BOJ accounted for about 20% of the average daily yen turnover. In one fell swoop it recycled all of last year's trade surplus (in the first eight month of the 2011, Japan is recording a trade deficit). However, if the size is breath-taking, the actual impact is hardly inspiring.

Given the poor track record of intervention, unilateral or multilateral, sterilized or unsterilized, there may be no compelling need to understand why the $100 bln intervention is not sticking. All sorts of possible explanations seem partly at play. Intervention has not been repeated. The failure to push the greenback above JPY80 lent bullish yen safe haven views intact. Spot intervention is less effective than repeated operations in the swaps and options market too, as the SNB is thought to have done.

In any event, another force may be at work and that is the floods in Thailand. They have hit the Japanese auto sector hard as Thailand is an important production base. Other industries have also been hit as reports by Hitachi and Canon indicate.

The strength of the yen had provided a significant inducement to Japanese companies to locate production off shore, like Japanese auto makers in the US for example. Thailand is an important Asian production and export platform for Japanese companies. Japan accounted for a little more than a half of foreign direct investment approvals in Thailand last year.

Toyota, Honda and Isuzu have cut production due to parts shortages and the cuts and part shortage is expected to impact North American facilities as well. Electronics producers are also being hurt as the global supply chains are disrupted. This has been one of the factors cited behind the drop of 2-gigabit DRAM chips to a record low price today of 79 cents.

The disruption of supply chains will be translated into lower profits and earnings for many Japanese companies. This in turn may slow direct investment and, on the margins, may increase corporate repatriation flows. These are not typically the flows associated with currency movement, but may at times have a larger impact or signal a broader impact.

The Nikkei has under-performed the other G7 equity markets over the past week and past month. For most of the year the yen (vs the dollar) has been negatively correlated with the Nikkei on both a 30- and 60-day rolling basis. Both have turned positive since the start of the month. While the sign has changed, the level of correlation remains statistically insignificant. It is something, however, that investors will want to continue to monitor.

The yen's performance in recent weeks against the dollar suggests that the 2-year interest rate differential, which has in the past been cited by the BOJ governor as an important driver, appears to be exerting only weak influence at the present. Both appear to be trading in relatively tight ranges.