25 October 2016
Safe-haven demands aren't the reason for capital inflows into Japan that have been driving up the yen. Photo: Bloomberg
Safe-haven demands aren't the reason for capital inflows into Japan that have been driving up the yen. Photo: Bloomberg

Is the yen really that safe?

International Monetary Fund president Christine Lagarde warned on Tuesday that the IMF’s global outlook, to be released on April 12, will not bring any good news.

The downside risk is getting bigger, and frustration with sluggish economic growth may push some to retreat into protectionism, she said.

After experiencing the selloff in global stock markets in January, investors were badly frightened.

Despite recoveries seen in stock markets around the world, strengthening emerging markets currencies and rising commodities prices, worried investors are always ready to leave the field or seek risk-averse assets.

The uptrend in the Japanese yen is an obvious sign.

Since Jan. 29, after the Japanese central bank announced a negative interest rate policy, the yen has been strengthening instead of weakening.

It has bounced between 112 to 114 against the US dollar recently.

As Lagarde spoke Tuesday, the exchange rate fell as low as 110.27. I believe it will fall below 110 sooner or later.

Many in the market explain this as the rising risk-aversion requirements of investors resulting in capital inflows into Japan.

But I doubt it.

Today, information technology is highly advanced.

Messages are sent and received almost simultaneously.

So we need to figure out what is the cause and what is the result.

Is the decline in oil prices and stock markets leading to a rising yen?

Or, on the contrary, is the strengthening yen resulting in declines in the stock market and oil prices?

Here are some questions that can help give us a clue:

1. Since the three major currencies in the world are the US dollar, the euro and the yen, why aren’t safety-seeking investors choosing the US dollar?

2. If the rise of the yen was caused by lowered expectations that the US Federal Reserve will raise interest rates, will an expanded negative interest rate scheme in Japan lead to the same market reaction as we saw on Jan. 29?

3. A side effect of quantitative easing policies is the rise of government debt levels. At the end of last year, Japan’s treasury debt accounted for 229 percent of its gross domestic product, while the leverage of the United States was only 73.6 percent. Who is carrying the higher risk?

The yen has long had a leading role in carry trades.

However a Deutsche Bank report pointed out in September that, after the renminbi’s one-off depreciation in August, the carry trades had their worst performance since 2008.

After Japan announced its negative interest rate policy, the country’s insurance and pension money rushed overseas to seek higher returns, while much overseas money began to buy Japanese government bonds and used cross-currency asset swaps to raise the return.

These capital flows are not dominated by risk-aversion demands.

This article appeared in the Hong Kong Economic Journal on April 7.

Translation by Myssie You

[Chinese version 中文版]

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head of private banking and trust services at Hang Seng Bank

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