The views expressed in this column are solely those of the
author and do not reflect the views of SVB Financial Group, or Silicon Valley
Bank, or any of its affiliates.
The 9.0 magnitude
earthquake that hit the northeastern coast of Japan on March 11, 2:46 p.m. JST
was the most powerful on record. The following tsunamis, extensive fires and
nuclear power plant explosion in the Fukushima prefecture exacerbated the damage
of the quake. The cost of rebuilding from Japan's devastating earthquake and
tsunami could reach $235 billion, or 4 percent of Japan's GDP, the World Bank
said in a report Sunday. That compares with $100 billion in damages, or about 2
percent of gross domestic product, from the 1995 Kobe
earthquake.
Why JPY strengthens?
The yen's surge
in the wake of the earthquake and tsunami may have seemed counter-intuitive at
first glance, but it reflected, in part, market speculation that Japanese firms
and the Japanese government will repatriate money now invested overseas in order
to pay insurance claims and the cost of rebuilding. The massive reconstruction
and repair task ahead of Japan is constructive for the Japanese yen (JPY).
In general, the financing of reconstruction could come from a mixture of
sources: insurance companies, government bond issuance, asset liquidation and
reallocations of public spending. Given Japan is the world's largest creditor
nation and the world's second largest current account surplus, financing flows
from these financing sources are expected to support JPY. Funds that have been
invested abroad by Japanese investors and corporations will be repatriated back
into Japan for rebuilding. Foreign insurance companies may need to purchase JPY
to provide pay-outs to Japan. Japanese insurance companies that have not
invested enough in Japan to cover their losses will have to liquidate their
holdings of stocks and bonds abroad and buy back JPY.
On top of that,
there is no outflow of investment funds to offset the repatriation flows as
Japan does not have a large amount of overseas hot money investments that tend
to move in and out of the country frequently. Japan's bond market is the
second-largest to the U.S. in outstanding debt in circulation, and the
overwhelming bulk of public debt is held domestically. Foreign bond purchase at
the cost of JGB's is a risk-seeking action for the Japanese investors and banks.
The decline in risk appetite will dampen appetite for overseas investments.
Thus, it is highly unlikely that they would shift their funds away from JGB's
into overseas investments under current national crisis, virtually eliminating
the exposure to capital flight and any massive JPY selling.
Japan also
enjoys its status as one of the several international reserve currencies, and as
a safe haven, one of the few currencies to appreciate versus the USD during the
recent global financial crisis. The appreciation of the JPY following the
earthquake is reminiscent of how the USD appreciated as a safe haven amid the
subprime mortgage crisis. This special status was underscored last week when the
JPY strengthened to a post-WW2 high of 76.25 against the USD, soaring past the
previous record of 79.75 reached in April 1995 in the aftermath of the 1995 Kobe
earthquake.
Concerted intervention to stabilize
JPY
To curb the JPY surge, the G7 countries conducted a joint FX
market intervention last Thursday. USD/JPY jumped up to around 81-82 after the
intervention from about 79. The Bank of Japan is estimated to have sold about
two trillion JPY (USD 25 billion).
The Bank of Japan and their G7
partners seek to counter one of the biggest economic threats as Japan rebuilds:
that sharp appreciation of the JPY to uncompetitive levels could be a drag on
the Japanese economy, which depends heavily on exports for economic growth. The
joint intervention aims to achieve an "announcement effect," to defend the 80
level for the USD/JPY. By containing JPY they could reduce the squeeze on
exporter earnings, helping corporate and investor sentiment to recover, a key
factor in reviving growth and helping restore stability to asset markets after a
turbulent week.
The G7 statement indicates that the market action was a
result of Japan's request to the U.S., UK, Canada and ECB for "concerted
intervention." The statement further indicates that the move reflects G7's
concern about "excess volatility and disorderly movement in exchange rates,"
which could have adverse implications for economic and financial stability.
What happens to JPY next?
While the
effectiveness of the intervention remains to be seen, the G7 delivered a strong
message and action. The joint intervention is likely to have a meaningful impact
in discouraging speculative JPY purchases in the short term. It has successfully
defined a psychological bottom at around 79-80, beyond which could heighten
chances of more intervention.
Ultimately, similar to the joint
intervention in 2000, it is about stability, not driving the JPY down. If the
USD/JPY stabilizes a decent clip above where they started for a couple of weeks
and then drifted down gradually over the next month or so, that will be deemed a
successful intervention.
The risk for JPY in the next few months is
biased towards more appreciation. General risk aversion, currently driven by the
unstable situation at Japan's damaged nuclear power plant and ongoing tension in
the Middle East, tends to strengthen the JPY as safe haven. Moreover, as
Japanese investors' risk appetite declines given this devastating natural
disaster, JPY selling will be diminished as JPY will not be used as a funding
currency to support purchases of risky assets.
It is true that JPY
appreciation since the earthquake has been largely attributable to the market
speculation over the repatriation of funds, and not necessarily to the actual
repatriation flows. But experiences from the 1995 earthquake in Japan indicate
that real repatriation efforts do not begin in full force until weeks and months
after the quake itself. Also, note that the rise in risk reduction tendencies
may lead to increase in FX hedge ratios for foreign assets held by Japanese
investors and corporations.
As a result, JPY will rise as repatriations
actually occur in the coming months, given there will be less flows to offset
JPY purchases. JPY could become the strongest currency in the coming months as
JPY appreciation will advance not only in USD but against other currencies as
well.
The views expressed in this column are solely those of
the author and do not reflect the views of SVB Financial Group, or Silicon
Valley Bank, or any of its affiliates. This material, including without
limitation the statistical information herein, is provided for informational
purposes only. The material is based in part upon information from third-party
sources that we believe to be reliable, but which has not been independently
verified by us and, as such, we do not represent that the information is
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