The 9.0 magnitude earthquake that struck Japan on March 11th has caused widespread destruction in the northern part of the island nation, leaving thousands dead and hundreds of thousands homeless. The quake ripped through buildings and created a tsunami that reached more than 30 feet high in some places, laying waste to coastal regions that would have otherwise been relatively unscathed by the actual quake. In recent days attention on the aftermath of the temblor has focused on the Fukushima nuclear power plant, which due to flooding and quake damage has been pushed to the brink of a full-scale meltdown that could have severe and long-lasting ramifications that reach far beyond Japan.
As a result of this humanitarian and environmental crisis, Japan finds itself facing an economic crisis as well. Though the region of the country impacted directly by the quake accounts for only a small portion of GDP, the effect of the natural disaster is being felt throughout the world’s third-largest economy. In the wake of the devastation, investors have run for the exits of Japanese stock markets; some indexes and Japan ETFs are down 10% or more in the week since the quake hit. Such a reaction makes perfect sense given the swirling uncertainty and adverse economic impact of the quake. What may seem confusing, however, is the performance of the Japanese yen in the sessions since the quake hit.
A general exodus from all things Japanese was perhaps expected, but the country’s currency has shown remarkable strength over the last week. The Japanese yen has skyrocketed against the dollar, reaching its highest value against the greenback since the end of the second World War at one point. On Wednesday, the dollar fell as low as 76.54, dipping under the previous all time low set in 1995. The dollar has recovered since then, but the yen remains considerably stronger than it was before the quake.
So why would the yen strengthen against the dollar during what Japan’s leader has called the biggest crisis in the nation’s post war history? The explanations for this seemingly bizarre phenomenon are three-fold: Expectations from the Bank of Japan, speculative attacks, and the repatriation of assets.
First, and most importantly, is the large wave of asset repatriation sweeping the country. Numerous Japanese investors, be it those engaged in the carry trade or just investors who have bought foreign securities, are likely to bring assets back home to Japanese soil, increasing demand for the yen and boosting the value of the currency in the process. Furthermore, the expectation is that insurance companies with assets overseas will begin a large scale repatriation in order to pay claims related to the quake. The same may apply to non-insurance companies as well. Japanese corporations are expected to move holdings from foreign markets back to Japan in order to fund rebuilding efforts in coming months.
There is a historical precedent for such a repatriation. The dollar’s previous low against the yen came in the wake of the massive Kobe earthquake in 1995; that disaster sent the Japanese currency sharply higher as local demand for the yen strengthened and Japanese investors cut off international investments.
Another explanation for the yen’s strength lies in the behavior of Japanese investors in the aftermath of the quake. A group that can usually be counted upon to drive capital outflows in a normal environment has understandably elected to keep capital within Japanese borders. “Japanese investors have a capital surplus that under normal circumstances they need to deploy abroad,” says Jens Nordvig, head of G10 FX Strategy at Nomura Securities. “In times of risk aversion, they will probably hold back in buying overseas assets.”
Central Bank Idle ... For Now
Japan’s central bank has a history of taking actions to discourage a strong yen, some of which have drawn criticisms from the international community. There is a growing suspicion among some investors that Japan may get a free pass on currency intervention given the context around any decision, which could soon pave the way for the government to begin selling the home currency and buying up dollars and other foreign currencies in order to keep exports cheap. Some see the situation from another angle that could keep intervention off the table for the immediate future. “It would seem that Japan’s bigger interest right now is in getting imports cheaper,” writes Joe Weisenthal. “Japan is going to need to import a lot, especially on the energy front in the wake of this crisis. A strong yen aids that effort significantly.”
Lastly, some policy analysts point to speculators as the culprit for the skyrocketing yen, as the currency gained more than 340 pips against the dollar in a half hour period on Thursday. This move reflects a change of about 4% and came despite no major new information, leading many to believe that speculators were at work looking to make a quick profit amid the historic volatility. “A successful test of the 80.00 prompted speculators to attack the JPY once it was determined the the BOJ would not put up any significant resistance,” said Michael Woolfork of BNY Mellon.
Boon ... For Now
The strength of the yen has helped to offset the sharp declines in the value of Japan ETFs in recent trading sessions. Through Thursday, the iShares MSCI Japan Index Fund (EWJ) has dropped about 8% during a one week stretch. The WisdomTree Japan Hedged Equity Fund (DXJ), which strips out exposure to exchange rate fluctuations, was down more than 12% over the same period. The gap between these funds serves as a powerful illustration of the potential impact of currency movements on international stock returns. Most investors with exposure to Japanese stocks also have exposure to the value of the Japanese yen, whether they realize it or not.
A strong yen is ultimately a negative for the Japanese economy, as it makes exports more expensive to international consumers. As such, some investors are growing concerned that the central bank will soon step in and attempt to reverse the yen’s climb, perhaps even coordinating such an effort with other countries.
With volatility in the exchange rate expected to persist in coming sessions, there are several options for achieving exposure to the yen through ETFs. Options for going long the yen include:
- CurrencyShares Japanese Yen Trust (FXY)
- iPath JPY/USD Exchange Rate ETN (JYN)
- WisdomTree Dreyfus Japanese Yen Fund (JYF)
- ProShares Ultra Yen (YCL)
For investors expecting the yen to reverse course in the near future, the ProShares UltraShort Yen Fund (YCS) might make for an interesting option. This fund is designed to deliver daily results equal to -200% of the daily change in the value of the yen relative to the dollar, essentially amplifying exposure to the currency.
Disclosure: No positions at time of writing.
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