I was asked a question yesterday on how the BOJ goes about intervening and why are credit lines an important issue.
The FX market at its core is made up of a large number of banks who each have credit lines with each other. (Reuters and the CME did try to introduce an exchange-type market some years ago and although this attempt failed, it’s unlikely to be the last). These individual credit lines allow the banks to trade up to a certain amount with each other, on a daily basis. Spot market clearance is two days, so spot deals will not have the same impact on the overall credit lines as might long-term complicated deal structures. Once this credit line is full, the counterparties are unable to deal with each other. This means that often times on interbank platforms there is what is known as a ‘choice’ price ie the bid and the offer are the same but no transaction takes place because the two counterparties have no ‘line’ or ‘limit’ for each other.
The exact same rule applies to central banks. The BOJ will have very large trading lines with all of the major banks but as they bought $100 billion, most of these lines will have been filled up by the end of the day on Monday last. These spot deals take two days to fully clear so in theory, the BOJ has little it can do but wait until they clear and then the trading lines become free again. They could of course increase trading lines just for intervention purposes, but I’m not sure that would sound too good.
I hope that explains the process, if not, fire lots of questions at Gerry, he’ll be thrilled
