What's going on with the Japanese Yen?

Mar 22, 2011

This week has been incredibly volatile for many financial markets. The earthquake and subsequent Tsunami has caused stock markets to plummet, and the ongoing nuclear crisis at Fukushima has continued to keep markets unsettled. While the fall in stock markets makes sense given the recent events, one market that has left investors puzzled is the Japanese Yen.

If a country experiences a catastrophe like Japan has, one would expect their currency to fall. Certainly the Japanese economy will have to bear high costs to rebuild whatever damage has been done, so they are undoubtedly worse off. Why then did the yen rise to its highest level since World War II during the week?

The yen is a strange currency that tends to behave in the opposite way to what one would expect. When bad economic news about Japan comes out, the yen tends to rise. When good economic news about Japan comes out, the yen tends to fall. The yen behaves very much like a safe haven currency, rising on bad news and falling on good news.

Just because the yen behaves like a safe haven currency does not mean that it is one. Is it really sensible to think that if a catastrophe hits Japan, people around the world start buying yen? If investors around the world are not rushing to buy yen, then who is?

The primary buyers of the yen during these times are Japanese investors themselves. Why would they be buying their own currency? They are buying back their own currency primarily because they have a lot of overseas investments. In the last decade, Japan has had extremely low interest rates. The stock market has also performed poorly. The fact is that investment returns in Japan have been low across asset classes, and investors have looked to overseas investments to earn higher returns.

This fact should help explain why the yen behaves in the opposite way to most currencies. When times are good, Japanese investors sell yen, buy foreign currencies and make investments overseas. When times are bad, they sell their overseas investments, and buy back the yen.

The recent crisis in Japan has led to Japanese investors buying back yen. The rise in the yen has also occurred due to the anticipation that Japanese investors will buy yen. Is the rise in yen likely to continue if the situation in Japan does not improve?

It is unlikely that the yen can continue rising on bad news. There will come a point when Japanese investors have already bought back most of the yen they previously sold. However, it is extremely difficult to tell when this occurs. One thing is for sure. The more bad news there is, the more volatile the yen (and other markets) be. Some evidence of this - at the end of the week, global central banks intervened to weaken the yen - and the currency is now right back where it started the week.

Disclosure: I do not hold the currency/commodity discussed in this report