The Yen as we all know has served as a safe haven currency along with the US dollar. In times of economic turmoil, the Yen has tended to act as a hedge and as investors take shelter in its safe haven status, they drive up its value. Due to near zero Japanese interest rates, the Yen has also served as a pet currency for carry trade. Investors borrow the Yen at negligible interest rates and invest in other higher yielding currencies. When financial turmoil hits markets, a massive unwinding of carry trade leads to foreign currency holdings being sold and capital being brought back to Japan, from where it was borrowed cheap. This leads to the purchase of the Yen and makes it appreciate. This correlation almost always translated into an inverse relationship between the Yen and stock markets. A rising Yen would usually accompany falling stock markets and vice versa.
However, new developments with the Japanese economy, including its greater contraction than the European and the US economy seems to have made investors rethink on the safe haven status of the Yen. The Japanese economy seems to have taken a severe hit due to a steep fall in its exports. Demand from recession hit markets in US, Europe and elsewhere seem to have put the Japanese economy in a tight fix. A steep fall in exports of 45.7% took Japan’s trade deficit to 9.9 billion dollars in January. Japan’s trade deficit was seen highest since 1986, in January this year.
The Yen’s status as a hedge currency and its usage for carry trade, which gave it its inverse relationship with stock markets, was evident throughout 2008. In March 2008, the collapse of Bear Sterns led to a strengthening of the Yen along with falling stock markets. This relationship has persisted almost throughout the last year, with any bad news resulting in depressed stock markets accompanied by a strengthening in the Yen.
The Yen’s holy relationship with stock markets may be set for a decoupling, with recent eventualities. Recently, with a slew of bad news on Japan, the Yen weakened beyond 96 against the US dollar, which appears to be an indicator of the decoupling effect. This decoupling may result in further weakness for the Yen as the major factors supporting its value has weakened.
Well, is this a good thing or a bad thing is something one needs to examine further. We are all aware that the main factor that has hit Japan is a huge contraction in exports. Exports have weakened due to shrinking global demand, which has hit the demand for Japanese auto and electronic products. Besides, global demand, Japanese exports were also hit due to the appreciation of the Yen. A more expensive Yen automatically makes Japanese goods more expensive in other currencies, dampening their demand even further. In this context, a downward correction in the yen’s value is likely to provide some impetus to Japanese exports and help the nation in cushioning its free fall. This is also likely to be beneficial for the global economy, which appears to be contracting faster by the day, with latest projections suggesting negative global growth for 2009!