Archived IMT (2010.09.16)

CHINA-JAPAN FOREX BATTLE. Wednesday's powerful intervention (JPY 2 trln worth of currency selling) may be a loud warning shot to Beijing given the record buying of Japanese Government Bonds from China. Cynics (possibly realists) could reason that China aims at hampering Japan’s recovery by keeping the yen excessively strong, while profiting along the way (via accumulating appreciating yen and gradually reducing exposure to depreciating US dollars). After all, the race for the 2nd biggest economy remains in close contention between China and Japan. Japans finance minister Noda has already stated I dont know the true intention, referring to Chinas JPY 583 bln purchases of JGBs in July after JPY 457 bln of purchases in June. Why would the Japanese Finance Minister raise suspicions about a nation purchasing bonds of the 3rd largest economy. The post-intervention statements from Tokyo regarding its resolve to pursue further action sound like a warning shot to Beijings yen-purchases as opposed to the average currency speculator. HOW WOULD BEIJING REACT? It could do so by tightening monetary policy via a rate hike and not merely raising the reserve requirement especially-- after August CPI jumped to 3.5%. A PBOC tightening would have TWO OBJECTIVES; 1) address Washingtons currency pressure on China. Followers of US-China currency diplomacy RECALL THAT BEIJING HAS USUALLY RESPONDED to mounting US FX pressures by tightening policy (either via raising rates or the reserve requirements on the basis that it is moving towards a market-based mechanism of monetary policy) instead of via currency revaluation; 2) A policy tightening would upset the risk trade (especially as S&P500 struggles near the 1130 resistance) and lead to fresh JPY strengthening, which would work in the favour of Chinas growing yen holdings.