Why Did The Yen Rally After North Korean Missile Tests?

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Includes: FXY, JYN, YCL, YCS
by: Metal and Currency

Summary

The yen has risen in the face of clear geopolitical threats against Japan.

The yen is not really a safe haven asset. Japanese multinationals are simply converting capital back to their home currency.

Forex speculators have no reason to buy the yen because speculators have no incentive to reduce exchange rate volatility.

North Korea has successfully fired a ballistic missile across Japan, triggering a flight to safety into several important safe haven assets. The goal of this article is to explore the rationale behind the paradoxical surge in the Japanese yen against the U.S. dollar and explain why I think the Japanese yen is the worst way to protect a portfolio against geopolitical risk.

The increase in the Japanese yen is unwarranted because the Japanese economy is under direct threat from East Asian military escalation and the Japanese inflation rate is too low for the BOJ to increase interest rates. Stagnant Japanese wage growth continues to be a deflationary pressure, even as GDP grows at a respectable rate. Buying into the yen is a miscalculation, and the Japanese currency is set to fall against the dollar.

Safe-Haven Assets

Several assets have consistently rallied in the face of North Korean geopolitical risk: Gold, crypto currency, the Japanese yen, and the Swiss Franc. However, among the traditional currencies, it is paradoxical to see the Japanese yen rising despite geopolitical risk at its doorstep.

This is in contrast to the currency of nearby nations like South Korea, which saw its won fall significantly after the missile test. Some speculate that this trend is caused by Japanese overseas investors reducing their exchange rate risk by unwinding positions held in other currencies and converting capital back into their home currency. Takuji Okubo, chief economist at Japan Macro Advisors, makes this claim:

For those Japanese investors who are invested overseas, having their assets in non-yen is a risk because they are exposed to foreign-exchange volatility," he said earlier this month. "So when these geopolitical risks, or any risks, get heightened, they want to reduce risk and that means unwinding overseas investments.

However, while forex de-risking may be the rationale behind the yen's rally, it doesn't make buying the yen a good idea for speculators. I believe Japanese corporations bought the yen because they make financial reports in Japan and are not trying to profit from currency fluctuations. The thesis is supported by the example of the Swiss Franc, another nation with massive overseas investments. The Swiss currency also moves as a "safe haven" when its corporations bring capital home due to political risk.

This thesis is supported by the example of the Swiss Franc, another nation with massive overseas investments. The Swiss currency also moves as a "safe haven" when its corporations bring capital home due to political risk. Both the Franc and the Yen opened higher after the missile test:

Chart FXF Price data by YCharts

Speculators should not buy into the yen to hedge against political risk because, unlike corporations, our goal is to chase forex volatility not avoid it. Corporations reduce forex exposure so they can focus on core business operations, and this is the real reason currencies like the Japanese yen rally when the fundamentals do not support upside.

Conclusion

Japanese multinationals are reducing their forex exposure by bringing capital back to their home country. Investors should not mistake this as a sign that the Japanese economy is safe or that there is any fundamental basis for upside in the yen. The yen still suffers from low inflation, and Japan's stagnant wage growth will keep the deflationary pressure on the economy. The yen's fundamentals suggest downside in the currency.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.