Do you remember the “Cash for Clunkers” program enacted by the U.S. government to help the U.S. Car industry? It offered a generous cash rebate to car buyers who traded in their old car.
While there were lots of cars sold during Cash for Clunkers, all it did was pull sales from future months. Everyone who thought about buying a car in the next 3 months pushed the car purchase forward to get a check from the government.
Car sales plummeted after “Cash for Clunkers”
How does this relate to G-7 interventions in the yen? Anybody who is thinking about buying yen in the next few months will want to do it when there is a huge Government program selling yen. Why wait and potentially lose another 5%?
My view on Bank of Japan (BoJ) intervention in the yen is that it is more likely to cause the yen to rally rather than weaken. The presence of a known, huge seller of yen is likely to attract large buyers of yen.
I’ve seen the “Cash for Clunkers” scenario unfold a several times over the years. Any time you have a large government program purchasing or selling Financial Assets, it pulls activity from the future into the time of the program.
The yen sales by the G-7 haven’t even made a dent in the yen . The yen is still trading up against the former all time highs. A 4 ½ month wedge formation broke after the earthquake. (Remember, on USDJPY charts, lower means a stronger yen.)
- Quantitative Easing I: During QE I, Treasury Bond prices tumble, despite huge Fed purchases. The day the Fed ends QE I, the bonds begin a major multi-month rally.
- BoJ 2004 yen Interventions: During the Interventions, the yen continues to get stronger despite frantic sales of yen totaling $345 Billion by the BoJ. Two weeks after the intervention ends, the yen begins a 9.5% decline over 6 weeks. In real terms (inflation adjusted) the yen gets 40% weaker over the next 3 years.
How it works – Quantitative Easing I
During Quantitative Easing I, the Federal Reserve bought U.S. Treasury bonds. Despite these purchases, the bond market sold off heavily during the time of QE I.
In real time March 2010, people were panicking about the end of Quantitative Easing I. There was rampant speculation about just who would be left to buy bonds after the Fed stopped its massive purchases in April 2010. Bill Gross warned of about bond yields exploding after the first round of Quantitative Easing ended – just like he is warning now about QE II.
“All this printing money will cause a huge spike in inflation”, the Bond Vigilantes said, “so bonds are doomed. Bonds will lose another 10-15 points after QE ends. Sell bonds now while you can.”
Of course, Treasury bonds immediately begin a huge rally after Quantitative Easing I stopped. As soon as the program ended, the bond market turned around and began one of the great rallies in bond market history.
Let’s apply the “Cash for Clunkers” model to Quantitative Easing. The Fed buying treasuries attracts sellers of bonds – weak holders who were thinking of selling anyway. If you are a weak holder of bonds, you’re going to sell when the Fed is buying. After all, who will be left to buy Treasuries when the Fed stops buying? Who wants to sell bonds during what promises to be one of the great selloffs in history? Sell bonds now, while you can — this is the logic being applied.
On-the-fence bond longs want to sell to the Fed, rather then sell during a free fall when the Fed goes away. Anyone who had plans to sell bonds in April-May-June 2010 sold them early, in February-March 2010.
So after QE officially ends, there is nobody left to sell bonds – everyone who wanted to sell already sold. Bill Gross should be asking “Who will be left to sell bonds after June 30th, 2011?”
This mental model has the benefit of matching what happened in the markets for QE I, and the 2004 yen interventions, and somewhat during the 1995 G-7 yen interventions. It also helps to explain the traders intuition to fade government market interventions. Sometimes, large orders are like chum in the water, attracting even larger orders on the other side.
Implications for the yen
Watch the yen strength and any BoJ interventions. If we see further interventions, the initial yen response may be to get stronger. The large sales by the BoJ could attract motivated buyers and pull purchases of yen from the future. Then, once the interventions end, there may be a rather sharp and quick weakening of the yen as the market activity tumbles.
There is a similar market dynamic in the “Cash for Clunkers” program, and any financial interventions like Quantitative Easing and Currency Interventions.