Why was the yen volatile at April 2016 BoJ meeting?

The Japanese yen saw one of the wildest moves ever this year so far, losing close to 5.90% on a weekly basis. In comparative terms, this week’s strong declines in USDJPY stands only next to August 2015, when USDJPY fell 4.87% on the week amid a flash crash that saw investors rush to safety bidding up the yen.

But this week, the yen’s rally (or USDJPY’s declines) was for a different reason. In order to understand why the yen was so volatile this week, we need to build some context.

USDJPY - YTD 2016 Performance
USDJPY – YTD 2016 Performance

Since the start of the year, the yen started off on a firm footing, after the December’s Fed rate hike. With interest rates starting to be hiked for the first time since the 2008 global financial crisis, the markets which got used to easy monetary policy saw a flight to safety which saw gold along with the yen posting strong rallies. By January, the Fed opted to keep rates on hold but that didn’t let investors give up the yen. Continued positions being built up on the safe haven currency saw the USDJPY continue to trade weaker in a steady fashion.

BoJ’s Negative Interest Rates

The Bank of Japan, in late January surprised the markets by announcing a rate cut, bringing Japan’s key interest rate from zero percent to -0.10%. Back then USDJPY was down over 5% since the December Fed rate hike. Despite cutting interesting rates, the USDJPY’s bounce was only short lived as investors went back to buy the yen, further sending USDJPY lower.

Japan is an economy that is reliant on exports. Therefore, a weaker currency bodes well for the export dependent economy. However, with the yen appreciating against the US dollar, the Japan’s export industry got hit as well. This was well reflected in the Nikkei 225 index which is made up of many export companies.

BoJ doesn’t like strong yen

Due to the apparent impact of a strong yen on the economy, the markets widely expected the Bank of Japan to intervene in the markets. Indeed, ahead of April’s BoJ meeting, various officials came out strongly in support of a weaker yen, with some members warning speculators that taking excessive long positions on the yen would be risky and that the central bank was watching the rapid appreciation in the yen. However, this was widely met with criticism among the global community with some even going to the lengths of accusing Japan for artificially keeping its currency lower to gain an edge with its exports. Despite the strong warnings, the BoJ did not do much leaving most of the markets to continue buying the yen and sending it stronger.

Speculation mounts ahead of the BoJ meeting

Precisely a week before the Bank of Japan was scheduled to meet, Bloomberg reported that the Bank of Japan was considering an ECB style negative lending rate in order to boost lending and spur growth.

Having adopted a negative interest rate on some excess reserves to penalize financial institutions for leaving money idle, the Bank of Japan may consider helping them lend by offering a negative rate on some loans, according to people familiar with talks at the BOJ

This report, citing “unnamed BoJ officials” saw the markets quickly sell the yen helping USDJPY to recover strongly. Expectations mounted that the Bank of Japan would unleash a host of measures, including expanding its QE purchases from the current 80 trillion yen, cutting interest rates even deeper and including introducing the negative lending rates for banks.

Besides the speculation, investors were also heavily long on the yen. As of April 19th, according to the CFTC weekly CoT report, investors were net long $8.2 billion, marking a record high net long positions in the yen. Such extreme positioning often leads to a short squeeze in the markets as well. The chart below shows the yen position based on the CFTC’s Commitment of Traders report for April 19 and April 26th (It still doesn’t cover the positions after April 28th BoJ meeting).

JPY CoT Report Positioning Comparison
JPY CoT Report Positioning Comparison

When the D-day came however, the Bank of Japan surprised the markets by leaving monetary policy unchanged. This caught the markets by surprise as the yen gained sharply on the BoJ inaction. Within a few minutes USDJPY fell by nearly 80 pips as shown in the chart below.

USDJPY Reaction to BoJ’s no-change announcement
USDJPY Reaction to BoJ’s no-change announcement

What followed later was a bit of a recovery before the market started to heavily buy the yen again, resulting in a weekly USDJPY decline of over 5.90%.