BNY Mellon: USD/JPY versus USD/CNY

8 feb 2019

By Simon Derrick, Chief Currency Strategist, BNY Mellon

• Japan appears to have achieved currency stability without needing FX intervention
• Realized volatility in USD/CNY continues to trend higher
• Could Beijing react?

One-year realized volatility (measured on an open/high/low/close basis) for USD/JPY currently stands at close to the lowest level seen in over a quarter of a century.

This is a remarkable when it is remembered that between 1991 and the start of 2004 the BOJ intervened on 369 separate days (approximately one day in every 11) in order to try and maintain stability in the JPY.

There have, in fairness, been three substantial spikes in realized volatility in USD/JPY since 2001, when the BOJ first introduced QE. However, it is noticeable that the sharpest spike in volatility (over the period of the global financial crisis) came during the only period that the BOJ was not using some form of quantitative easing.

While there is a strong argument that external factors played a significant role in the latter stages of the November 2012 - December 2013 move (the taper tantrum) and the October 2014 - December 2016 shift (the Brexit referendum and the US presidential election), in both cases the start of the move was monetary policy related.

More specifically, in late 2012 the start of the rise in volatility was driven by a sharp weakening in the JPY thanks to the promise of Abenomics, while the October 2014 move coincided with another sharp weakening thanks to a controversial increase in the QE program at the end of that month.

It seems unlikely that either of these moves was ultimately particularly concerning for Japan. The genesis of both spikes in volatility came on the back of a QE-related material weakening of the JPY.

Moreover, the broad trend lower in realized volatility since the start of 2017 as the BOJ’s QQE program has continued to run has left USD/JPY trading in very comfortable range (with the lower boundary roughly coinciding with the pair’s 20-year moving average).

If QE has seemingly achieved for the Japanese authorities what active intervention in the FX couldn’t then it’s also interesting to consider what’s been happening with USD/CNY since 2014.

In November 2013 the PBOC’s governor signaled that the bank would “basically” exit from regular intervention on the currency market.

Following this announcement FX reserve growth drew to a close in a matter of months. Coincident with this policy shift, realized volatility in USD/CNY began to trend steadily higher.

The net result of this sustained move is that while one-year realized volatility in USD/CNY has still some way to go before it matches that of USD/JPY, this could happen later this year, should current trends persist.

Indeed, there has been at least one day over the past three months that has seen a higher level of overnight realized volatility in USD/CNY than in USD/JPY.  

This pattern is not unique to the JPY. Recent months have seen an increasing convergence between levels of overnight realized volatility in USD/CNY and in EUR/USD (see chart above).

This raises an interesting question: if QE has achieved what FX intervention could not in terms of currency stability, then at what point might China start accusing those who use it of currency manipulation?