Morning Brief – It is what it is

It is what it is

Yesterday, as virus fears closed in on London’s financial markets the value of the Pound Sterling, as well as UK equities, has stumbled. The sell-off in London’s FTSE 100 was echoed on Wall Street with major US indices closing in the red. Commodity prices also took a step lower as markets focussed on the impact of a potential second coronavirus outbreak that would cap global demand as well as the impact of the upcoming week-long holiday in China. One potential beneficiary of rising uncertainty and risk could be the Japanese Yen, a long-standing safe-haven currency during times of turbulence. But has Japan’s recent political handover, balance sheet growth and deteriorating global trade changed the safe-haven status of this export-driven economy’s currency?

There are many reasons why the Yen is considered a safe-haven but the most important of these is history and behaviour. During times of global market distress the Yen usually rallies versus its peers and even against a safe-haven flow into the US Dollar, USDJPY usually falls. The theories as to why the Yen is a safe-haven are often long, convoluted and even contradictory. They range from the assumption that Japanese hedge funds reliably repatriate money during global crises raising demand for the Yen at the expense of foreign currencies, to the persistently low interest rates that the Yen attracts making it a funding currency that is purchased back during market volatility and uncertainty. During the height of the pandemic domestic concerns surrounding the spread of the virus within Japan prevented the Yen from benefiting from its normal safe-haven flow. Instead markets trusted in Gold, the US Dollar and developed government bonds. So perhaps the Yen has lost its status after all?

Not quite. The appeal of the Yen is not some indomitable force guiding markets towards the currency in times of distress. Domestic issues can and do prevent it from securing a safe-haven bid in markets. As Japan controlled its own outbreak of the pandemic normal service was resumed and the Yen rallied from around 110 to the Dollar before the pandemic to around 104 today. Crucially for the status of the Yen, during yesterday’s market sell-off and worry about a second wave of the pandemic there was evidence of strong Yen demand.

Two facts stand to undermine the Yen’s appeal as a safe-haven. Firstly, during the pandemic outbreak there was no evidence of domestic Japanese funds unwinding asset allocations abroad and repatriating the financial revenues of those sales to Japan. This stands in violation of the Yen’s classic safe-haven justification. Secondly, the resignation of Japanese Prime Minister Shinzo Abe on health grounds abruptly ended an eight year premiership. Rising political risk alongside an evaporation of the economic fundamental that drove investors to the perception of smooth shores in the Yen could have dragged the tide out on the currency’s safe-haven appeal.

Fortunately for proponents of the Yen as a safe-haven, the appointment of Yoshihide Suga as Japan’s Prime Minister will preserve the political status quo as far as possible. Mr Suga will champion the same kind of loose monetary policy and a new era of fiscal expansion meaning the policy shift will be in name only: Abenomics to Suganomics. Due to the engrained status of the Yen as a haven it is unlikely it fails to attract a safe-haven bid during times of uncertainty so long as domestic conditions remain palatable. For now, “because it is” will continue to suffice for an explanation of why the Yen is a safe-haven. However, it will be important that the Yen retains healthy demand as equity market valuations adjust to the prospect or forbid reality of a second wave in infections. With the Yen right at the peak of its medium-term range against the Dollar, maintaining its momentum could be a challenging task.

Discussion and Analysis by Charles Porter

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