JPY: Geopolitical risk in East Asia – Deutsche Bank

The yen, as the currency of a creditor nation, tends to rise in immediate reaction to national crises, explains Taisuke Tanaka, Strategist at Deutsche Bank.

Key Quotes

“Forex markets in times of crisis generally go through three phases: (1) a reduction in risk positions and securing of liquidity; (2) frictions between debtor and creditor nations; and (3) a change in the fundamentals. Both Korea and Japan are vulnerable to harm in the event of a crisis in East Asia. The possibilities are vast, so we restrict ourselves here to the reaction of yen markets in terms of (1) and (2) above.” 

“The yen surged rapidly after the earthquakes of 1995 and 2011, when Japan suffered massive damage (albeit from natural disasters). A widespread belief is that the yen was buoyed by repatriation of the currency for insurance payouts. However, currency flows for such insurance purposes were relatively small and did not occur immediately after an earthquake. In fact, the stubborn risk aversion of financial flows in creditor Japan puts upward pressure on the yen. This was exacerbated by speculative yen buying as well as special factors in 1995 and 2011, such as position adjustments and risk reduction, generating an appreciation in the currency.” 

“The Korean won (KRW) is presently experiencing a selloff. The KRW, as a creditor currency, has always been inherently strong and has tended to move symmetrically to the JPY, also a creditor currency. As Korea has maintained a current account surplus for over 15 years, the KRW generally moves in line with the Japanese currency. However, there are also weaknesses associated with a creditor position that have yet to be resolved. Korea is considered the nation facing the most serious risk, and the KRW is accordingly being sold.”

“If Japan should become involved in the crisis, foreigners could seek to unload their Japanese assets, sparking a selloff of the yen. In the initial stages, however, we believe the main risk will be an appreciation in the currency from risk-off sentiment from a plunge in Japanese stocks. The present unwinding of speculative short positions since last month could be a reflection of (1) above. We do not consider such possibility lightly and hope fervently that no such crisis will come to reality.”