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During times of uncertainty, such as the prelude to the Brexit vote, investors tend to gravitate toward the Japanese yen.
This causes the yen to appreciate and has led to the common perception of the yen as a safe-haven currency. This strengthening of the Japanese currency during periods of risk aversion has become so repetitive and ingrained that it is rarely questioned. Aside from the many white papers and research studies demonstrating that conclusion, a quick review of recent events shows this to be the case.
During the financial crisis and its aftermath, the yen appreciated by more than 20 percent. Later, in , worries about peripheral European debt led to a 10 percent appreciation against the euro. Stay ahead of the herd — subscribe to our premier FS Insider podcast for daily updates and market news. Even when Japan was leveled by the Great East Japan earthquake in , the currency somehow managed to rise.
In terms of debt-to-GDP, Japan is blazing the trail. The answer to this question is multifaceted. But before getting into the details, we need to accept that yen strength is simply not a function of domestic economic performance. Japan has always been a large exporter and has continually exported significantly more goods and services than it imports. The result has been decades of current account surpluses that have positioned Japan as a net creditor to the world.
The value of foreign assets held by Japanese investors is substantially higher than the value of Japanese assets owned by foreign investors. The behavioral ramifications of this are simple: when markets become risk-averse, that money tends to move back home. This repatriation of capital coincides with a flow out of other currencies and into the Japanese yen, causing it to strengthen.
In addition to blazing the trail in terms of debt-to-GDP ratios, Japan has also been a leader in terms of low-interest rates. Attempting to stave off deflation and spur economic growth, Japan has held interest rates at rock-bottom levels for nearly 20 years.
When uncertainty subsequently hits global markets, it can cause investors to unwind these trades, which then results in additional demand for the yen. With technical analysis and the reading of chart patterns, investors are often taught to ignore the fundamentals, and instead, simply follow the price action. Investments from Japanese investors outside Japan create supply and thus a weakening factor for the Yen.
When there is less demand for these assets the price in Yen goes down and the Yen would strengthen. Trade Cash Flow Japan has a trade surplus and is exporting more than importing.
This keeps the currency strong. The strengthening currency could lower exports and increase imports in the long run. But in the short term it reinforces itself for example by reducing the supply of Yen required for imports.
Note that the U. This weakens the U. Investment Cash Flow There seems to be a strong demand from non-Japanese investors for Japanese assets, especially short-term money market instruments.
Overseas investors bought for example a net 5. The demand for assets outside Japan has definitely not been very strong recently; just think about how the stock markets around the world have behaved the last six months.
There is also the fact that Japanese savers have preferred Japanese Government Bonds for decades, allowing the Yen to stay strong despite world record low levels. Compare this with the low savings rate in the U. Demand for Japanese Assets Where is this demand from non-Japanese investors for Japanese assets one of the reasons the Yen is strengthening coming from?
Partly this could come from foreign reserves diversification. Think about China for example who wants to be less dependent on the U. Dollar or Euro. The Chinese central bank put a lot of money in the U. The Chinese bank then switched over to investing in Euros, and the Euro sovereign debt crisis occurred. It seems to make sense that the next diversification would be into Yen, as the Yen is holding its strength.
Chinese net purchases of Japanese debt have increased to 1. Other investors are seeking a temporary parking place for their money when they sell their other assets. With the poor performance of stock markets around the world, the very low interest rate on U.
There could also be a perception among market players that the U. Federal Reserve may be more willing to conduct aggressive monetary easing than the Bank of Japan. The expectation that more new U. Dollars will be printed than that there will be new Yen printed, will strengthen the Yen. This perception was further strengthened last week when the U. Federal Reserve in a statement indicated that it might embark on more quantitative easing, increasing the amount of money in circulation in an attempt to help the economy pick up.
The expectation for the differences in interest rate in Japan and the U. The Japanese interest rates have always been the lowest. But when the expectation is that this difference is will become less big e. The same thing will happen when investments outside Japan are expected to become more risky or providing lower returns.
Before investors borrowed Yen at very cheap interest rates, used it to invest in other countries where the returns were higher. Now there could be some unwinding or less carry trade paying back the loans in Japan and needing more Yen for that or exchanging less Yen than before.
Summary Thus in summary, repeating what we said above: the cause for the strengthening of the Yen is that the Yen is a currency with net inflows; more Yen are bought then that there are Yen sold.
Just some crazy after thoughts Is the strengthening of the Japanese Yen a clear indication for the expected weakness in the growth of the economy in the rest of the world? Is Japanese public debt a bubble? The ROI in Japan is too low to keep the money there unless you are a Japanese saver and unless the situation in the rest of the world is very bad. Japan is in the black hole corner of a stronger currency, lower corporate profits, lower stock prices, deflation, more locally financed public debt, a higher deficit, a continuous trade surplus and more inflow of money.
Due to demographics, the local demand will not increase to bring the trade cash flow in balance. Breaking the circle, weaken the currency and getting an outflow of money can only happen by declining exports this is not good for the Japanese companies and stock market , and by assets outside Japan being more attractive investment opportunities than the ones in Japan.
The Japanese nightmare scenario is that the economy in the rest of the world does not improve. The black hole corner then will suck in more money till the moment that debt and deficit are out of control, the population ages further while saving less, interest rates on the public debt rise and eventually Japan defaults on its debt.
And, only then the Yen will weaken. Does anybody see a scenario that is positive for Japan? The strengthening of the Yen fits well with a world where the inflation in Japan is lower or there is even deflation compared to the rest of the world.
Prices in Japan deflated in terms of Yen, but in terms of Dollars they keep up with the rest of the world. It is all in balance with each other. A topic for another article could be if the U. Dollar is getting weaker against the average of all other currencies and what are the reasons for that. Input is welcome. Net buying of overseas equities, bonds and money market instruments by Japanese investment trusts from January to July has risen 65 percent from the same period last year to 2.
Note however that overseas investment by Japanese mutual funds seems to go increasingly toward higher-yielding currencies rather than the dollar; such capital outflows will not provide much support to the U. Dollar then. Life insurers have increased their foreign securities investment to 1.
Note however that since the cost of hedging against foreign exchange risk is now relatively cheap, life insurers are likely having more currency-hedged investments, resulting probably in a lower net impact on currencies than otherwise.
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