Bank of Japan Shows Its Hand

The BoJ bought dollars in the open market for the first time since 1996 -- but that doesn't mean it will continue to do so.
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After warning that the yen's strength was undesirable, senior Japanese officials reportedly sanctioned intervention earlier today. This is the first time the

Bank of Japan

has bought dollars in the open market since April 1996. The intervention caught the market by surprise, triggering a short squeeze, and gave the dollar its biggest single-day boost in nearly five years, according to reports.

The dollar has lost 4.3% of its value against the yen since the start of the year. At the lows set earlier today, the mighty greenback, which caused so much consternation last summer, had fallen by nearly 33% from its August peak.

From a purely economic point of view, the sharp appreciation of the yen is tantamount to some degree of monetary tightening. And Japanese officials are keenly aware that this is among the last things the fragile Japanese economy needs at this juncture. This week's

DRI

, for example, has warned that Japan's economy may contract by as much as 3% this year. The forecast was based on the recent strength of the yen and the higher interest rates in Japan. While this may seem to be on the pessimistic side, the Japanese government itself, forever the optimist, has downgraded its growth forecast in FY99 to 0.5%, despite the 18% planned rise in public works spending and tax cuts.

As players scrambled to cover their previously sold dollar positions against the yen, the U.S. currency shot up to almost 113 yen from about the 108.20 yen level. For technicians, the price action has the makings of a key reversal -- the dollar initially slipped through yesterday's lows and now, of course, is trading well above yesterday's highs. In addition, with today's gains, some momentum indicators are likely to show bullish divergence for the dollar.

Yet a word of caution from a yen bear: The intervention is likely to be a one-off. It has achieved its purpose. It broke the one-way bet mode the market had slipped into. Market talk suggests the BoJ bought as much as $1 billion, which, given its modus operandi, is a relatively small amount. The market's reaction is a testimony to how overextended the market had become, and not necessarily a sign of new-found dollar bullishness by most market participants. The dollar now needs to rise above the 113.25-50 level against the yen to convince many of these participants that a significant low is in place. Otherwise, it should not be surprising to see a return to the 110-yen area in the next day or two.

One important consequence of the intervention is the subsequent comments by

Treasury

Secretary

Robert Rubin

, which should lay to rest speculation that U.S. dollar policy had changed. News wire reports quote Rubin specifically as saying that a strong dollar has served U.S. interests and there was "absolutely" no change in U.S. policy.

Note: Marc Chandler will be appearing on CNNfn at 3:40 today, talking about the action in the currency markets.

Marc Chandler is an independent global markets strategist, whose critical analyses of global currency and capital markets analyses appear on Mondays, Wednesdays and Friday mornings. At the time of publication, he holds no positions in the currencies or instruments discussed in this column. While he cannot provide investment advice or recommendations, he invites you to comment on his column by sending a letter to him at

mchandler@erols.com.