In the aftermath of April 7th, when American missiles hit the Shayrat airbase in Syria, from where US officials believe the gas attacks that killed more than 70 people were carried out, safe haven assets such as gold, the yen, government bonds and oil have reached multi-month peaks.
Generally, in case of geopolitical tensions and economic uncertainties, some goods and currencies are more favoured than others by risk-adverse investors. This is the case of the yen, which was at its highest level since November 2016, and 0.2% higher than the day before, at ¥110.64 per dollar. In fact, for the global co-head of forex at National Australia Bank, Ray Attrill, the yen is the go-to asset when markets are under stress.
Japan has always been an important indicator of market trends – proof of this the ¥1.52trn that Japanese investors pulled out of the French bond market in February, ahead of the French elections, despite their long history of fondness for French debt, according to a report by Société Générale.
Also, an International Monetary Fund report highlighted that the yen has appreciated at least a dozen times by 6% or more between the mid-1990s and 2013, each time when global risks threatened major stocks. The most prominent cases are when it appreciated over 20% during the 2008 global financial crisis, or in May 2010, when higher market distress about peripheral European sovereigns led to a large jump of 10% in the VIX index (the market expectation of stock market volatility over a 30-day period).
The Yen’s Historical Soundness
What made yen one of the so-called ‘safe haven’ assets can mainly be found in Japan’s economic policies and the reaction of Japanese investors to changes in markets.
Japan’s current account surplus is due to income from overseas investments more than trade. This view is reinforced by a Reuters article highlighting the exceeding value of assets held overseas by Japanese investors, compared to the value of Japanese assets owned by foreign investors. Some 90% of Japan’s debt is held by domestic investors, despite its size being twice the gross domestic product.
When markets get bearish, Japanese investors repatriate some of their money invested abroad, thus raising the value of the yen, and triggering a reaction of foreign investors which find a safe haven in the Japanese currency. In the words of Martin Schultz, an economist at Fujitsu Research Institute:
“Japan is a banker to the world, and when risk rises, investors look for a safe ‘bank’.”
Relationship with the Dollar
In trading terms, there is also a strong correlation between US treasury bonds and the USD/JPY exchange rate. When interest rates are expected to rise, US treasuries lose value, and as a consequence the US currency appreciates, making the USD/JPY pair go up. On the other hand, as interest rates fall, there is more appetite for treasury bonds which in turn appreciate, weakening the USD/JPY position. The reason for this inverse mechanism lies mainly in the fact that the US government will never default on its bond obligations.
The USD/JPY exchange rate is a hint of risk appetite in the market, because of its inverse correlation with yields. When panic occurs, treasury bond prices will rise, the dollar loses value and its exchange rate with the most important funding currency, the yen, appreciates. Selling a low yield currency can allow traders to execute carry trades (trades in which yen is borrowed at low rates, and invested in assets with higher return) effectively, mainly because of the low-interest rate of the yen compared the other currencies. When markets start to turn against speculators, they close the positions to pay back the loans.
The Back Story
According to Yukio Ishizuki, senior currency strategist at Daiwa Securities, the yen appreciated as a consequence of falling European equities, and rising US and European bond yields when, last February, France’s far-right National Front leader Marine Le Pen launched her presidential bid, aiming to take France out of the European Union. A similar phenomenon occurred in the immediate aftermath of the Brexit vote.
On the other hand, IMF analysts revealed that large movements in the yen during risk-off episodes occur without any visible movements in net capital flows, as shown in the graph, and especially in the decade between 2012 and 2015, when the yen depreciated by 13% following Prime Minister Shinzo Abe’s aggressive monetary easing and bold structural reforms. Since then, this process has been reversed, with a 15% jump in one year, mainly due to Japan’s current account surplus, low energy prices, and low US interest rates.
In political terms, this phenomenon of risk-off appreciation may appear undesirable because adjustment costs may occur in the economy, leading to economic dislocation when exchange rates come down, but public and private sector balance sheets are not inclined to incur in risky vulnerabilities due to such appreciation and capital flow increases.
On April 18th, the yen lost ground against the dollar, following the US Treasury Secretary Steven Mnuchin’s comments favouring long-term dollar strength, but the momentum passed, and dollars traded down 0.16%. Still, the future does not look bright for the yen.
In fact, according to media reports, investors are seeking refuge in the yen, following the latest tensions between the United States and North Korea, and ahead of the uncertainties of the French presidential election.
An eye should be kept on the ongoing US-Japan economic talks, in order to understand the possible trade policy under Donald Trump, especially following his protectionist remarks, and comments on countries that weaken their currencies in order to boost exports.
Also, as risk indicators traded at near 13 this month compared to 11 at the beginning of March in the CBOE Volatility Index, a fund manager at Ample Capital in Hong Kong, said that the future of markets is not bright, given the latest developments in the global outlook. Despite this, he also stated that many individual sectors and stocks may still have the capabilities to outperform, mainly because of qualities individual to equities and assets, just as in the case of yen.