Japan: Hold the ‘Kan can’ jokes please

So the fat lady has sung – or rather, the sumo wrestler has grunted – and Japan’s latest political circus is over (for now).
Naoto Kan has retained his somewhat battered position as the country’s prime minister, defeating the “shadow shogun” of his party — but only narrowly by 206-200 in the crucial vote among parliamentarians in the ruling DPJ. And, as the FT reports, all eyes are on the yen.
The big question among other pressing issues, as we noted earlier, is whether Kan and his crew will make good on their interminible pledges to act to curb the strong yen.
As the FT noted in an earlier report, concern about the strength of the yen, which hit a 15-year high of Y83.35 to the dollar last week and reached Y83.09 after Tuesday’s voting result, played a crucial role in the battle between Kan and his challenger, Ozawa — who had stated he would take “all possible action” to weaken the currency.
Bloomberg adds that Kan’s win “removes concern that an Ozawa-led government would drive bond yields higher by increasing borrowing to fund stimulus spending”.
While Kan easily won the popular vote among DPJ local members and delegates, the report adds, the narrowness of his win among party members in the Diet, or parliament, highlights the challenge he faces in uniting the party and enacting legislation to lower corporate taxes after losing control of the upper house in July.
Many observers predict that Kan will be forced to give Ozawa a key role in his government — although it’s highly doubtful he would offer any role that handles economic or financial policy.
On the issue of yen intervention threats, Kan, for his part, had repeatedely assured (ad nauseum) that he would act “decisively”. But despite a hyperactive rumour mill that picked up on any small sign of government preparation for a possible foray (進行突襲) into the currency markets, scepticism prevailed on Kan’s willingness — and ability — for bold action in the absence of US support for such a move.
Analysts were divided on Tuesday about the prospects for currency intervention.
RBS Securities said in a note that the chances of intervention following Kan’s victory “have somewhat declined” although the administration is likely to “maintain its stance in taking immediate and appropriate action if necessary”. That to us sounded rather — well, Japanese, rather like Kan’s own pronouncements.
On the government’s relationship with the Bank of Japan, however, RBS is clearer: government pressure on the central bank for additional easing measures “will be relatively mild compared” to that which would have come from an Ozawa administration.
In further points to those made in our earlier post, Steve Englander, head of G10 FX strategy at Citi, and his team noted:
On the surface the implications for USD/JPY are clear. PM Kan has seemed very reluctant to intervene, whereas Mr. Ozawa has made his view of intervention very clear. The FX market is focusing on intervention risk… If PM Kan wins … USDJPY is likely to start another round of decline.
And they added:
Our view so far has been that the MoF [Japanese finance ministry] would not intervene until USDJPY breaks down to 80, the historical low on USDJPY…<<--> SO WRONG~! On the next day Kan admitted the intervention of yen tos upport Export and Recovery, 82 would be the bottom line, yen immediately reached 85 >>
Even if PM Kan remains in power it is very possible that the view on JPY intervention will shift — especially if USDJPY breaks through its recent low of around 83. Recent comments from (prime minister) Kan and [finance minister] Noda have turned in a more hawkish direction, saying Japanese government will take decisive action including FX intervention when FX market gets too volatile. What’s more, last week the Japanese government decided an economic [simulus] package which has three steps to stimulate Japanese economy – and the first step is to address JPY appreciation and deflation. In this package Japanese government also mentioned it will take a decisive action including FX intervention.
Of course, USDJPY has had a strong correlation with US-Japan rate differentials in recent years and US rates have been trending up since the end of last month. If US rates keep on rising USDJPY would be held up above 83 by market forces. But without further US yield moves, and assuming that Mr. Kan wins, the odds are that we will pressure downward pressure on USDJPY to break the recent lows. But given the recent stance change from the MoF we would not rule out a more active response from the MoF than is currently priced in.
Two additional factors note the Citi team:
1) USDJPY has not reacted to the move in US interest raters and gap between what a standard rates based model would predict for USDJPY and the current price has widened. This opens the possibility that long yen positioning is bigger than the market believes. Certainly JPY longs on CFTC are at close to record highs and if anything our indications that model funds are long JPY have strengthened in recent days.
2) … we continue to think that the market overestimates the risk that US officials will have concerted opposition to Japanese intervention, given the deflationary implications of yen appreciation, and the extent to which Japan has slid out of the picture on trade issues. Co-ordinated intervention is off the table, but given the positioning and the degree to which rate differentials have diverged from spot, unilateral (一方的, 單邊的; 單方面的) intervention may have more impact than commonly believed.

Related links:FX intervention day? (Sept 08) – FT Alphaville
The politics of (yen) intervention (Sept 03) - FT Alphaville
The yen conundrum - CreditWritedowns
Japan, China and the intervention two-step (Sept 09) – FT Alphaville