Japan reportedly considers shorting crude oil to rescue the yen, prompting global analysts to collectively question the move.

As the news that “the Japanese government is considering shorting the crude oil futures market to intervene in the foreign exchange market” continues to develop, global analysts are expressing confusion, disbelief, and skepticism about the effectiveness of this unconventional idea.

As background, reports have emerged since Monday that Japan is weighing the direct use of its foreign exchange reserves to short the crude oil market in order to suppress oil prices, as conventional intervention tools have weakened in addressing stubborn inflation pressures. This is aimed at indirectly alleviating the depreciation pressure on the yen.

Subsequently, on Tuesday, Japan’s Finance Minister Shunichi Suzuki made remarks that made the market realize that Japan seems to genuinely be considering this matter. Suzuki stated that concerns about “speculative trading” in the crude oil futures market are impacting the foreign exchange market, and the Japanese government is prepared to “take all possible measures in all areas.”

According to informed sources, the Japanese Ministry of Finance has already contacted major banks engaged in oil trading in Tokyo to inquire about their views on intervening in the crude oil futures market.

How do oil prices correlate with the yen?

Japan’s crude oil consumption relies almost entirely on imports, with over 90% of its supply typically coming from the Middle East. Therefore, when energy costs suddenly rise, Japan needs more dollars to purchase crude oil, putting downward pressure on the yen.

Since the resurgence of conflict between the U.S. and Iran on February 28, Brent crude oil has surged from $70 per barrel to $100, peaking close to $120 during this period. The exchange rate of the dollar to yen has also jumped from 155 to around 160.

(Brent crude oil, USD/JPY daily chart, source: TradingView)

More critically, USD/JPY reaching 160 is seen as a key point for the Japanese government to intervene in the foreign exchange market. The last time Japanese authorities intervened in the foreign exchange market was between April and May 2024, when the yen exchange rate fell below 160. At that time, the Japanese government spent 5.9 trillion yen (approximately $37 billion).

(USD/JPY weekly chart, source: TradingView)

Therefore, whether or not to short the crude oil market, Japan is currently at a critical juncture where it needs to “rescue the exchange rate.” Japanese law allows foreign exchange reserves to be used in the futures market, but the prerequisite is that it must be used to stabilize the yen.

Is this approach effective?

It is currently unclear on which platform the Japanese government is preparing to operate, but informed sources indicate that, similar to currency intervention, such operations can take place on any platform, including the New York Mercantile Exchange trading WTI crude oil futures, the ICE trading Brent crude oil futures, or the Dubai Mercantile Exchange trading the Asian benchmark oil price.

Proponents of this innovative approach argue that the scale of futures and derivatives trading (i.e., the “paper oil market”) far exceeds physical supply, which means that related intervention measures, even if they only work through indirect channels, could still have actual effects.

Opponents also focus on two points: first, the root cause of the current surge in crude oil prices is the war in the Middle East, not disordered speculation in derivatives; second, Japan going it alone to short crude oil sounds implausible.

Yuriy Humber, CEO of Tokyo-based consulting firm Yuri Group, bluntly stated that it is impossible to mitigate the impact of physical oil shocks using financial means. If officials want the intervention to have an impact, it must be synchronized with the actual flow of crude oil. Ideally, this should be an international effort.

Tony Sycamore, an analyst at IG in Sydney, believes Japan may need to spend at least $10 to $20 billion to see results in the market. Sycamore said, “Whether Japan acts alone or in concert with other countries, I believe it makes no sense at all. The key to everything is opening the Strait of Hormuz.”

The U.S. government, which once considered intervening in the crude oil futures market, seems to have completely ruled out this option. U.S. Treasury Secretary Janet Yellen stated in mid-March, “We absolutely will not do that.”

Meanwhile, the ambiguous situation in the Middle East also makes shorting oil itself fraught with risks. If Japan builds positions and oil prices rise further, it could face huge losses with no assistance to the yen, exacerbating the pain from rising energy import costs.

Daisaku Ueno, chief foreign exchange strategist at Mitsubishi UFJ Morgan Stanley Securities, also stated that if foreign exchange reserves are significantly depleted during large-scale interventions, the general fiscal account could also tighten as a result.

As for why the conventional method of selling dollars and buying yen is not being used, there are speculations that Japanese authorities might have “difficulties expressing.”

Ueno commented that this may lead to speculation that the Japanese government is considering other means because it finds it difficult to sell dollars.

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(Source: Caixin)