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Fundamental Trading Strategy: Intervention
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…tain directional move in its currency. There are basically two types of in­tervention, sterilized and unsterilized. Sterilized intervention requires off­setting intervention with the buying or selling of government bonds, while unsterilized intervention involves no changes to the monetary base to off-set intervention. Many argue that unsterilized intervention has a more lasting effect on the currency than sterilized intervention.

Taking a look at some of the following case studies, it is apparent that interventions in general are important to watch and ran have large impacts on a currency pair's price action. Although the actual timing of intervention tends to be a surprise, quite often the market will begin talk­ing about the need for intervention days or weeks before the actual inter­vention occurs. The direction of intervention is generally always known in advance because the central bank will typically come across the newswires complaining about too much strength or weakness in its cur­rency. These warnings give traders a window of opportunity to partici­pate in what could be significant profit potentials or to stay out of the markets. The only thing to watch out for, which you will see in a case study, is that the sharp intervention-based rallies or sell-offs can quickly be reversed as speculators come into the market to fade the central bank. Whether or not the market fades the central bank depends on the fre­quency of central batik intervention, the success rate, the magnitude of the intervention, the timing of the intervention, and whether fundamen­tals support intervention. Overall though, intervention is much more prevalent in emerging market currencies than in the G-7 currencies since countries such as Thailand , Malaysia , and South Korea need to prevent their local currencies from appreciating too significantly such that the ap­preciation would hinder economic recovery and reduce the competitive­ness of the country's exports. The rarity of G-7 intervention makes the instances even more significant.

Japan

The biggest culprit of intervention in the G-7 markets over the past few years has been the Bank of Japan (BOJ). In 2003, the Japanese govern­ment spent a record Y20.1 trillion on intervention. This compares to the previous record of Y7.64 trillion that was spent in 1999. In the mouth of December 2003 (between November 27 and December 26) alone, the Japanese government sold Y2.25 trillion. The amount it spent on inter­vention that year represented 84 percent of the country's trade surplus. As an export-based economy, excess strength in the Japanese yen poses a significant risk to the country's manufacturers. The frequency and strength of BOJ intervention over the past few years created an invisible floor under USD/JPY. Although this floor has gradually descended from 115 to 100 between 2002 and 2005, the market still has an ingrained fear of seeing the hand of the BOJ and the Japanese Ministry of Finance once again. This fear is well justified because in the event of BOJ intervention, the average 100-pip daily range can easily triple. Additionally, at the ex­act time of intervention, USD/JPY has easily skyrocketed 100 pips in a matter of minutes.

In the first case study shown in Figure 9.23, the Japanese govern­ment came into the market and bought U.S. dollars and sold 1.04 trillion yen (approximately US$9 billion) on May 19, 2003 . The intervention happened around 7:00 a.m. EST. Prior to the intervention, USD/JPY was trading around 115.211. When intervention occurred at 7:00 a.m. , prices jumped 30 pips in one minute. By 7:30 , USD/JPY was a full 100 pips higher. At 2:30 p.m. EST , USD/JPY was 220 pips higher. Intervention generally results in anywhere between 100- and 200-pip movements. Trading on the side of intervention can be very profitable (though risky) even if prices end up reversing.

Figure 9.23 USD/JPY May 19, 2003

The second USD/JPY example (Figure 9.24) shows how a trader could still be on the side of intervention and profit even though prices reversed later in the day. On January 9, 2004 , the Japanese government came into the market to buy dollars and sell l.664 trillion yen (approximately US$15 billion). Prior to the intervention, USD/JPY was trading at approximately 106.60. When the BOJ came into the market at 12:22 a.m. EST , prices…

Figure 9.25 USD/JPY November 19, 2003

Eurozone

Japan is not the only major country to have intervened in its currency in recent years. The central bank of the Eurozone also came into the market to buy euros in 2000, when the single currency depreciated from 90 cents to 84 cents. In January 1999, when the euro was first launched, it was val­ued at 1.17 against the U.S. dollar. Due to the sharp slide, the European Central Bank (ECB) convinced the United States , Japan , the United King­dom , and Canada to join it in coordinated intervention to prop up the euro for the first time ever. The Eurozone felt concerned that the market was lacking confidence in its new currency but also feared that the slide in the currency was increasing the cost of the region's oil imports. With energy prices hitting 10-year highs at the time, Europe 's heavy dependence on oil imports necessitated a stronger currency. The United States agreed to in­tervention because buying euros and selling dollars would help to boost the value of European imports and aid in the funding of an already grow­ing U.S. trade deficit. Tokyo joined in the intervention because it was be­coming concerned that the weaker euro was posing a threat to Japan 's own exports. Although the ECB did not release details on the magnitude of its intervention, the Federal Reserve reported having purchased 1.5 bil­lion euros against the dollar on behalf of the ECB. Even though the actual intervention itself caught the market by surprise, the ECB gave good warning to the market with numerous bouts of verbal support from the ECB and European Union officials. For trading purposes, this would have given traders an opportunity to buy euros in anticipation of intervention or to avoid shorting the EUR/USD.

Figure 9.26 shows the price action of the EUR/USD on the day of in­tervention. Unfortunately, there is no minute data available dating back to September 2000, but from the daily chart we can see that on the day that the ECU intervened in the euro (September 22, 2000) with the help of its trade partners, the EUR/USD had a high-low range of more than 400 pips.

Figure 9.26 EUR/USD September 2000

Even though intervention does not happen often, it is a very important fundamental trading strategy because each time it occurs, price move­ments are substantial.

For traders, intervention has three major implications for trading:

•  Play intervention. Use concerted warnings from central bank offi­cials as a signal for possible intervention — the invisible floor created by the Japanese government has given USD/JPY bulls plenty of oppor­tunity to pick short-term bottoms.

There will always be contrarians among us, but fading intervention, though sometimes prof­itable, entails a significant amount of risk. One bout of intervention by…

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