Monday, June 11, 2012

Forex Intervention

I have been trading the forex market for over 30 years and have seen central banks intervene in all sorts of ways. In the wake of the recent global financial and economic crises, governments are taking a more active role in managing their economies. The following is written from memory and is an anecdotal history of forex interventions.

My first introduction to intervention was in 1977, soon after Japan allowed the JPY to trade internationally. I was running a bank dealing room in Singapore and would open a line to our Tokyo office to monitor that market (there were no screens in those days and forex trades were conducted by telex, telephone and voice broker. USD/JPY was trading around 310 at the time and the Bank of Japan (BOJ) would come into the market and intervene at a price for 0,000,000. This amount was large amount in those days and the BOJ would buy until it bought its limit. It would then pull its bid and renew it 2 big figures lower. If it held off the market, there would be a scramble to cover short positions ahead of the Tokyo close. I remember one time when USD/JPY was trading at 305.99-306.01, the BOJ being on the bid at 306.00. We has sold USD/JPY and got a running account on the telex from our Tokyo dealing room 15 minutes to the close, BOJ has bought 162 million 10 minutes to go, BOJ has bought 169 million, finally with 1 minute left the telex rang out change, 303.99-304.01. The BOJ reached its limit at 306 and then dropped its intervention level to 304.

Floating foreign exchange rates was a new business and central banks have gotten more sophisticated in their approach over the years. In the 1970s-1980s, they were still finding their way. It was then I learned not to base trading decisions on expectations that a central bank would be there via intervention to bail out a position. Major US banks had a direct line to the Fed dealing desk and would get calls asking about the market and placing orders, usually to smooth the price action. In those days the dollar was under pressure so most of the orders were to buy dollars. It was the early 1980s and I co-managed a trading operation for a commodities company. I had close relationships with many bank dealers and got call one day from a friend who was furious. The Fed had been in the market during the US afternoon each day for months buying dollars to cool speculation. This day, the Fed seemed to disappear and USD/DEM dropped several big figures out of nowhere. Where was the Fed? My friend, apparently caught the wrong way by the disappearing Fed, went ballistic and called to find out what happened. It turned out those manning the Fed trading desk went to lunch and forgot to leave the customary buy orders. I learned then never to count on a central bank top bail out a position.

The most noted intervention took place after the Plaza Accord, in September 1985, when the G7 got together in NYC and decided to weaken an overvalued dollar. The meeting was held in secret and caught the market by surprise, setting off a prolonged slide in the dollar. I remember getting the news at home looking at my portable quote machine and hitting the first usd/jpy bid I could find. The first reaction was one of those strange ones and the pair actually rebounded initially. I got out too soon once it started down again and have never seen that level again. With some hindsight, the clue to this intervention was that it was a coordinated effort.

It was less than two years later, in February 1987, that the G7 felt the need to put a halt to the dollar's slide. This led to the Louvre Accord, where the G7 agreed to stabilize exchange rates. All I remember of this time was a skeptical market and how much harder it was to stop a falling currency.

I don't remember the exact date but believe it was sometime in 1989 when European finance ministers met in Gleneagles Scotland over a weekend and announced support the falling dollar. I remember it well as we were short USD/DEM at 1.9850 in an environment where it appeared a safe bet to be short dollars. This weekend was not a safe bet. The surprise announcement saw the dollar gap higher. The first price we saw was 2.0850, a 10 big figure move. We were sick but fortunately not overleveraged. We stayed up all night and managed to trade out of the position with a small loss. Had we held on until the end of the week, we would have made money as the market renewed its attack on the dollar once it became clear the U.S. was not part of the agreement. Nonetheless, I never want to go through that experience again and recognized the pain that can be inflicted by a surprise intervention.

In 1992, the GBP was forced out of the ERM (European Exchange Rate Mechanism), where currencies traded within upper and lower bands vs. one another. Member central banks were required to support their currencies at the lower end of the band and vice versa at the upper end. The alternative was a revaluation or devaluation or an exit from the ERM. This was a famous incident where speculators attacked sterling and forced the UK to exit the ERM< which resulted in a near freefall in GBP. It is also an example of what could happen when intervention fails. In this regard, it seems the markets used to be more willing to test central bank resolve than nowadays, where they seem more content to be led by central banks. In the old days, intervention, especially if it was unilateral, was like waving a red flag in front of a charging bull.

I don't remember the date but believe it was in the 1990s when the BOJ bought about USD/JPY 30 bln during the month of March ahead of the Japanese fiscal yearend yet the pair continued to fall. In this case, the flows were so overwhelming that all the BOJ could do was supply liquidity to ease the impact. The intervention was not designed to reverse the trend but to slow its rise.

This brings us to the current market, where the Swiss National Bank (SNB) has taken a stand to prevent the CHF from appreciating. The SNB focus has been on eur/chf, where 1.50 appears to be the line in the sand. This intervention, while unilateral, has been effective in keeping eur/chf above 1.50 as the central bank has taken various tactics to keep the market off guard. Intervention was initially broadcast by the SNB that it did not want to see its currency appreciate. The SNB came in with a surprise attack buying eur/chf in the open market. It did this on several occasions before switching tactics when it became too predictable. The most recent interventions were apparantly carried out using Bank For International Settlements (BIS) as a surrogate. The BIS not only bought eur/chf and usd/chf, but did so at su7ccessively higher levels. Once the SNB pulled out, eur/chf eased back but is currently finding support above 1.52, which provides a cushion to the 1.50 line in the sand.

There are some lessons to be learned here. It is generally easier for a central bank to counter currency appreciation than to stop a falling knife (i.e. weakening currency). In the current trading world, where speculators are less likely to take on a central bank, it is better to step back and let the dust settle before trying to fade an intervention led move. Intervention is also more likely to be employed during times of tame inflation or deflation (such as current times) as a weaker currency can be inflationary.

This brings up another central bank which appears to be defending the downside, the Bank of Japan (on instructions from the Ministry of Finance). This is often referred to as stealth intervention, which is carried out by surrogates (e.g. government pension funds, etc). It appears that usd/jpy 95 is the current line of defense with dips below it finding bids. Unlike past times, when the focus was on export competitiveness to the United States, the current strategy appears to be focused on China. The goal is probably to keep usd/jpy in a range (e.g. 95-105) as long as China keeps usd/cny in a narrow range. This is likely to remain the case until China's economy stabilizes so expect the stealth intervention to continue.

This sums about a brief anecdotal history of intervention in the forex market. While I am sure I missed many instances, the stories should give enough background to put the current and future interventions in perspective.

Copyright (c) 2009 Jay Meisler

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