With the turmoil in the global economy and currency markets, a trader needs to find a safe haven for his hard earned profits. Let’s evaluate if it is time to go long on the Yen, which may be considered a safe bet, though with low yields.
Currency after currency seems to be bearing the brunt of the current currency turmoil. The trigger for the bursting of the bubble appears to have been the sub-prime crisis in the US, but the underlying reason for the turmoil has yet been not very clear.
A careful scrutiny of various currencies, however, seems to suggest a commonality between this untoward behavior of various currencies. Some of the nations that are bearing the brunt of weakened currencies also seem to be the ones with exceptionally large current account deficits. And we all know that Uncle Economics says that the currency of an economy with a large current account deficit should depreciate vis-à-vis currencies of economies that have surpluses or lower deficits. Up till now, it appears that nations with high current account deficits managed to support appreciating currencies along with low inflation on the back of cheap imports from China and reinvestment of current account surpluses by surplus nations into them.
Reinvestment from foreign capital surplus nations like China and the Middle East has helped finance the current account deficits of the likes of the US, Britain etc, making their currencies appreciate, which in turn kept imports cheaper and checked inflation. Cheap Chinese products and an artificially depressed Yuan helped fuel this virtuous cycle. Another key factor that helped this virtuous cycle was Yen based carry trade. Traders borrowed in Yen, which had near zero interest rates, and invested in high yielding currencies. This led to a surge of capital to finance current account deficits of nations with higher interest rates and helped sustain their current account deficits. But this worked well till all was going well. With the sudden emergence of instability in the global currency markets, the appetite for risk suddenly fell. This has probably resulted in the unwinding of carry trades and sustaining these huge current account deficits is becoming difficult resulting in the depreciation of these currencies.
As the global turmoil helps separate the wheat from the chaff, two currencies, which are backed by current account surpluses, have emerged stronger than the rest. Both the Japanese Yen and Swiss Franc, which had stayed subdued up till now in spite of their current account surpluses, are showing trends of strength. And currencies of economies that have current account deficits are demonstrating weakness.
Thus, as the global risk appetite subdues, investors and traders are seeking safe havens for their investment. The Yen is emerging as one of the best safe havens as Japan is running a trade surplus and inflation has not made too much of a dent as yet. But, true to the saying, ‘no pain – no gain’ or as per the ‘risk-return’ trade-off, investment in the Yen will mean lowered returns as interest rates in Japan are much lower than most other economies. But in times of distress, safety may be a better bet than a losses!!