Japanese yen ¥: sayonara safe haven?

19 February 2020

Mansoor Mohi-uddinMacro Strategist, NatWest Markets

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When the going gets tough in financial markets, investors have often turned to the Japanese yen for safety, whether that’s through assets or the currency directly. This pattern has, however, unravelled over the past few years. Here are four factors driving the change.

Is the yen’s safe-haven status unravelling?

It used to be the case that when investors were confident, Japan’s stock market would rise and the yen would fall. When the market’s mood darkened, investors would sell shares and the yen would rise. As a result, the yen has tended to appreciate during times of uncertainty over the past couple of decades. Yet more recently the world’s third most-traded currency hasn’t been behaving in the ways we’ve come to expect.

Meanwhile, there’ve been several instances recently when Japanese government bond yields have fallen and prices have risen in response to economic and geopolitical uncertainty, but the yen’s move has been muted. Do these trends suggest the yen’s days as a safe haven are numbered?

Four factors limiting the yen’s value as a safe haven

To answer this question, we’ve identified four factors that are driving the yen’s value:

1. The carry trade

The first is that the yen has become less popular with speculative currency traders. Before the 2008 financial crisis, the markets were driven by the ‘carry trade’, whereby investors borrowed in currencies with low rates and invested the proceeds in countries with high rates.

Carry trades funded in yen are less attractive these days because rates across the developed world are all closer to zero – so there’s less carry to exploit. In the past, the value of the yen would rise as investors unwound their currency positions during periods of uncertainty. With fewer positions to unwind now, the yen’s response is less pronounced.

2. The trade deficit

Another reason is that Japan has been running a trade deficit since it closed down its nuclear power stations and began importing energy following the 2011 earthquake and Fukushima disaster. This situation makes the yen less responsive when conditions become economically or geopolitically challenging.

In the past, foreign exchange rates have been be driven by trade flows if investment capital evaporates during uncertain times. When Japan had a large trade surplus, the yen would tend to rise. But its deficit now drags down the value of the currency – even when investors become cautious.

The world’s third most-traded currency hasn’t been behaving in the ways we’ve come to expect.

Although Japan receives substantial net investment income, these inflows don’t offer the yen much support either. As they seek higher returns than those on offer from domestic assets, the country’s fund managers tend to recycle the proceeds from their foreign investments back into overseas markets.

3. The move towards foreign assets by Japan’s GPIF

The third reason concerns Japan’s Government Pension Investment Fund (GPIF), which is the world’s largest, with ¥162 trillion (around $1.5 trillion) under management. Since 2014 it has been diversifying away from domestic government bonds and towards foreign assets – and other Japanese funds have been copying its approach (figure 1). When the GPIF buys on market dips, its strategy means the yen is less responsive when investors are shunning risk.

Figure 1: Shifting asset allocations

Japan’s Government Pension Investment Fund has been diversifying its portfolio away from domestic government bonds and towards foreign assets.

Source: NatWest Markets, Bloomberg.

4. Shifting local dynamics

The fourth reason that’s preventing the yen from rising during when markets are stressed is that Japanese firms are taking over from Chinese companies as Asia’s largest overseas Mergers & Acquisitions dealmakers. This shift is partly due to tighter capital controls the Chinese government introduced as part of its efforts to prevent the yuan from appreciating.

At the same time, Japanese executives faced with an ageing population and shrinking domestic market are looking for exposure to growing overseas markets. By selling the yen and buying foreign currencies to facilitate their deals, Japanese companies hold back their currency, even when investors are averse to taking risk.

Japanese executives faced with an ageing population and shrinking domestic market are looking for exposure to growing overseas markets.

Unlikely to lose safe-haven status completely

Although we’ve identified four factors blunting the yen’s traditional role as a currency that rallies when investors are nervous, we believe it’s unlikely to lose its safe-haven status completely. Although several events have unnerved investors over the past decade, including the 2011 eurozone debt crisis, 2015 Chinese yuan devaluation and 2016 UK referendum, they have yet to be fully tested.

When markets do suffer an event as extreme as the 2008 financial crisis, Japanese portfolio managers would probably begin to sell their foreign assets, which would push up the value of the yen. Therefore, Japan’s currency still has the potential to act as a safe haven and outperform if the global economy suffers a significant shock.

FX
Regional focus: Japan
Fixed income
M&A
Carry Trade
Trade Deficit


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