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Many market commentators have noted that the JPY appreciation in the wake of the earthquake is “normal” since Japan, on the whole, has a high savings rate and reconstruction needs will trigger either capital repatriation or lower outflows. The yen is also cushioned by Japan’s current account surplus.

Commentators recalled that the 1995 Kobe earthquake was followed by a 20% fall in the USD/JPY (NYSEARCA:JYN), and the same could happen today. This could bring the USD/JPY down to 67, which would be a very bad outcome from the USD perspective.

(Click to enlarge)
Technical analysis suggests that the USD/JPY trend remains in a bearish zone of resistance below 84.50/73. A break below 80 would provide a strong bearish signal in the coming months.
In this case, historical comparison is ill-advised. In 1995, the Japanese economy was finally showing signs of robustness after several years of debt deflation, while the Fed was close to ending its monetary policy tightening.
Furthermore, the Sensai earthquake caused significantly more damage than Kobe, which suggests that there should be non-linearities in economic and financial reactions. The Japanese economy may take time to recover from the pressures of earthquake and tsunami damages, a fire in a major oil refinery, and the shutting down of a nuclear power plant.
Perhaps the most striking difference between 1995 and today is the regime shift in the relationship between risk aversion (VIX) and the USD/JPY. While prior correlation seemed to fluctuate between positive and negative, the current position leads us to believe that there will be a continued negative correlation.

Higher risk aversion should drive risky assets down and may be at fault for driving the USD/JPY lower. We use two metrics to gauge the probable relationship and the FX-implied risk aversion level.
For a long time, the AUD/JPY has been a metric of risk appetite, and has sustained a strong relationship with carry trade strategies. AUD/CHF is another way of comparing “risk on” (long AUD) vs. “risk off” (long CHF). Both charts below show our estimates of AUD/JPY and AUD/CHF and their position within fair value bounds.

The AUD/JPY is slightly below fair value, pointing toward the yen’s strength. Statistical analysis may suggest a rebound in AUD/JPY. The AUD/CHF is also below fair value, suggesting that risk aversion has reached a threshold.
Yet, the contribution of VIX in the case of both of these metrics remains low from a historical standpoint

The main reason for AUD/CHF and AUD/JPY to breakout on the downside would be a much higher VIX.

The economic fundamentals (current account balance and financial out/inflows) may justify a stronger yen. In the short run, however, our cross assets analysis suggests that it would also require – or be joined by – a further fall in risky asset prices and the breakout of some significant levels for AUD/JPY and AUD/CHF.
Source: Why Is the Yen Rallying?