ABNORMAL YEN STRENGTH MAY NOT LAST LONG

DIRECTOR OF CURRENCY RESEARCH, GFT

IMAGINE a country with a debt-to-GDP ratio in excess of 200 per cent, faced with a massive natural disaster that leads to a nuclear emergency. The situation deteriorates further as a third of the country’s energy’s production is lost. Under normal conditions, that country’s currency would come under sustained selling pressure. However, there is nothing normal about the Japanese yen.

Turning all of the logical market assumptions upside down, the Japanese yen remained well bid this week even as other financial assets such as Japanese stocks plunged. The Nikkei recorded its worst two-day decline since 1987 in the wake of an explosion at the troubled Fukushima nuclear power plant that may have released dangerous levels of radiation into the air. As the Nikkei plumbed its lows, dropping below the 9,000 level, yen was within striking distance of its all time highs with dollar-yen trading below the ¥81.00 figure.

What’s been going on? Why did the yen challenge all conventional wisdom this week? Although yen’s recent price action may appear confusing, there is method to the madness of the currency markets.

The yen has been rallying for two primary reasons – repatriation and risk aversion. Currency traders have been speculating that the huge casualty damage caused by the earthquake and the tsunami will force Japanese insurance companies to repatriate funds in order to pay out the claims. At the same time, the unwinding of many speculative carry trades such as Australian dollar-yen, euro-yen and Canadian dollar-yen created a natural bid for the unit despite the horrible news from the land of the rising sun.

However, given the severity of the situation at Fukushima and the very real possibility that the human and economic tragedy may be far greater than the consensus view, yen could start to weaken as the focus shifts away from repatriation flows to the economic cost of recovery. For now, dollar-yen continues to drift towards its all time lows, but if the situation at Fukushima turns into a full blown nuclear emergency, yen’s strength may not last.

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