The foreign-exchange market “went berserk” last week, as James Mackintosh put it in the FT. On Wednesday, the yen surged past ¥79.75 to the US dollar. That matched its previous post-1945 high against the greenback, reached in 1995 after the earthquake in Kobe. It then jumped another 4% within just 20 minutes.
Why the yen rocketed
One reason why the currency jumped is that it has long been viewed as a global safe haven. But leveraged investors unwinding carry trades reinforced the move. Carry traders borrow low-yielding yen, sell them and invest the proceeds in higher-yielding currencies such as the Australian dollar. A sharp rise in the yen causes a loss on these trades, prompting investors to unwind them and thus buy back yen.
Moreover, investors bet that Japanese firms, notably insurers, will repatriate money from selling overseas assets, causing widespread yen buying. The upshot was that the yen was soaring just as Japan needed a boost from exports to spur growth. For a big exporter, a stronger currency is a form of monetary tightening, “which it needs like a hole in the head”, says Jeremy Warner on Telegraph.co.uk.
- For an explanation of the yen carry trade, see Tim Bennett’s video tutorial: carry trades
To lower the yen, the world’s seven major industrialised nations approved late last week the first multilateral intervention in currency markets since 2000. Back then they banded together to shore up the euro. After major central banks sold around $25bn worth of yen late last week, it fell and steadied at around ¥81 to the dollar.
What next?
As Richard Fletcher notes in The Daily Telegraph, whether G7 intervention succeeds in stabilising the yen, or whether any further interventions will be needed, will only become clear over the next few months. But the danger of further yen gains seem smaller than many believe.
Dig into “the hard numbers”, and speculation that life- and non-life insurers are set to repatriate cash after ditching overseas assets “looks to be a false alarm”, says Hideyuki Sano on Reuters.com. As far as life insurers are concerned, over half their foreign bonds are currency-hedged. And their overall currency exposure amounts to just 5% of total assets. Even assuming a hefty hit from the earthquake, it’s hard to see their forex-selling amounting to more than ¥10bn-¥20bn. That’s a tiny sum in the context of a forex market with a daily turnover of $4trn. Non-life insurers’ sales would be bigger, but still hardly significant.
In any case, insurers have plenty of cash reserves and would dip into Japanese government bond holdings “if the worst came to the worst”, according to Yuji Saito of Crédit Agricole. “They have no reason to sell foreign assets.” And banks, “flush with deposits, are unlikely to need extra money to cover their losses on Japanese stocks”, adds Wayne Arnold on Breakingviews.com.
Yen strength will be short-lived
The idea that repatriation could drive up the yen stems from the widespread belief that this was the key reason the yen rose after Kobe. But Japanese authorities have contested this idea. Mizuho’s Jonathan Allum points out that, in March 1995, a few weeks after the Kobe quake, there was less repatriation than in the same month in 1994 and 1996. It seems “repatriation is just another urban myth”.
The strong yen is also largely due to dollar weakness: on a trade-weighted basis (against a basket of trading partners’ currencies), the yen is weaker than it was for much of the 1990s. Besides, says Mansoor Mohi-uddin of UBS, the cost of reconstruction, along with the near-term hit to the economy, will put more strain on public finances. More money printing, and the fact that Japan looks further away from raising interest rates than other major economies, also imply a weaker currency. So yen strength “is likely to be short-lived”.