Why the yen is a haven

July 9, 2016 1:00 pm JST

Why the yen is a haven

ISAYA SHIMIZU, Nikkei senior staff writer

TOKYO -- It is conventional wisdom: Investors buy the yen when global market sentiment worsens. But why? Why is the currency of a country whose economy is on the skids a haven?

On June 24, a day after Britain voted to leave the European Union, the yen strengthened against major currencies.

Investors fear that the mandate for the U.K. to break away from the EU will negatively impact the global economy. They also fear Brexit may be a canary in a more global coal mine.

So many of them shifted their holdings into yen-denominated assets.

Similar shifts took place during the global financial crisis, which hit in 2008, and after the earthquake, tsunami and reactor meltdowns brought Japan to a halt in 2011.

Japan has been battling deflation for nearly 20 years. It has daunting structural problems, too, such as a declining worker population and creaking infrastructure. A massive fiscal deficit is another concern. The Bank of Japan estimates that the economy's potential growth rate is about 0.2%, much lower than the 2% or so for the U.S.

So, again, why is the yen a haven?

Toru Sasaki of JPMorgan Chase Bank said it is important to note that there is little correlation between the strength of a nation's economy and that of its currency. Currencies can come under selling pressure at times of economic turmoil, though currencies of lower-growth countries often strengthen.

Yields

Where there is a correlation is between prices and exchange rates. When prices of goods and services fall, the value of a currency increases. When goods and services can be purchased for less money, a currency gains purchasing power.

So what currency do you want to hold? one that has more purchasing power or one that has less? Most investors want currencies with more purchasing power.

 

Japan fell into deflation 18 years ago. The BOJ's quantitative and qualitative easing program, adopted in April 2013, helped boost prices for a while. But it got overwhelmed by tumbling crude oil prices and sluggish consumer spending.

Japan's consumer price index fell 0.4% in May from a year earlier. In the same month, U.S. prices got 1% fatter.

As for the correlation between interest rates and exchange rates, interest rates are usually low in slow-growth countries like Japan, where central bankers try to make money as cheap as possible so cash can do its job of seeding growth.

The BOJ adopted a zero interest rate policy 17 years ago. It now has a partial negative interest rate policy. This has helped push down the yield on 10-year Japanese government bonds to minus 0.3%, lower than the yields on similar U.S. and German instruments.

Kicked out

It is normally thought that the currencies of countries with ultralow interest rates are more likely to come under selling pressure. Low interest rates, after all, do not appeal to those who want their nest eggs grow.

They do, however, appeal to investors who get an itch to place risky bets. Speculators sometimes place these bets by borrowing in yen, then using the Japanese currency to buy a currency of a country with high interest rates and high market fluctuation risk.

There is a term for this: the yen-carry trade.

In times of market turmoil, however, currencies of countries with ultralow interest rates are more likely to come under buying pressure. The speculators, now worried, want to unwind their carry-trade positions.

As a result, the yen spikes.

Analysts' views are divided as to how common carry trades are. Still, though, psychology plays an important role in the market, so mere expectations for carry-trade unwinding are enough to convince investors to buy the yen during times of turmoil.

As of the end of 2015, Japan's net foreign assets -- overseas assets held by the government, companies and individuals minus their overseas debts -- came to about 339 trillion yen ($3.36 trillion). This is one of the world's largest asset piles.

It is also behind the yen's haven status. An economic shock would prompt Japanese investors to repatriate their foreign-currency-denominated assets. In other words, there would be a sudden rush to buy yen.

That said, Daisaku Ueno, chief foreign exchange strategist at Mitsubishi UFJ Morgan Stanley Securities, is skeptical that the yen will retain this status forever. If the country's fiscal conditions continue to deteriorate and inflation rears its head, the yen would be kicked out of club haven.