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 crude oil futures to intervene in the foreign exchange market” continues to ferment, global analysts are expressing confusion, disbelief, and pessimism about the effectiveness of this unprecedented idea.

As background, it was reported on Monday that due to the diminishing effects of conventional intervention tools in dealing with stubborn inflationary pressures, Japan is weighing the direct use of foreign exchange reserves to short crude oil in order to indirectly alleviate the pressure of yen depreciation.

Subsequently, Japanese Finance Minister Katsunobu Kato’s remarks on Tuesday made the market aware that Japan seems to be seriously considering this matter. Kato stated that there are concerns that “speculative trading” in the crude oil futures market is affecting 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 seek opinions on intervening in crude oil futures.

How do oil prices correlate with the yen?

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

Since the resurgence of conflict between the United States and Iran on February 28, Brent crude oil has surged from $70 per barrel to $100, peaking at nearly $120 during this period. The USD/JPY exchange rate also rose from 155 to about 160.

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

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

(USD/JPY weekly chart, source: TradingView)

Therefore, whether or not to short the crude oil market, Japan has reached a critical point where it needs to “rescue the exchange rate.” Japanese law permits the use of foreign exchange reserves for futures market interventions, but the premise is to stabilize the yen.

Is this approach effective?

It is currently unclear on which platform the Japanese government plans to operate, but informed sources say that, like currency interventions, such operations can be conducted on any platform, including the New York Mercantile Exchange for WTI crude oil futures, ICE for Brent crude oil futures, or the Dubai Mercantile Exchange for Asian benchmark oil prices.

Proponents of this innovative approach believe 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 focus on two points: first, the root cause of the current surge in crude oil prices is the Middle Eastern war, not disordered speculation in derivatives; second, Japan acting alone to short crude oil does not sound credible.

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

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

The U.S. government, which had previously 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 confusing situation in the Middle East also makes shorting crude oil itself full of risks. If Japan builds a position and oil prices further surge, it could face significant losses and provide no relief for 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 reduced in a large-scale intervention, the general fiscal account may also become tight as a result.

As for why conventional methods such as selling dollars and buying yen are not utilized, there are speculations that Japanese authorities may have “difficulties that cannot be spoken of.”

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

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(Source: Caixin)