Unraveling the JPY trade

February 15, 2019

Markets had experienced a whole lot of volatility towards the end of December to close out 2018 and the beginning of the new year was no different. On January 3rd, in the early hours of Asian trading, the FX markets were rumbled when the Japanese Yen (JPY), experienced tremendous gains against major global currencies in a short period of time. It appreciated as much as 3% against the US Dollar in just 8 minutes, 10 percent against the Turkish Lira and 8 percent against the AUS Dollar. This event has been defined as a ‘flash-crash’ by analysts in the weeks since. Analysts have attributed this sudden move to two main reasons: Firstly, this event occurred between 5:30 pm and 6:30 pm Eastern Standard Time, when North American markets are closing whereas Asian markets in Hong Kong, Tokyo etc. have not fully picked pace. This led to very low trading volumes, thus causing heavy volatility on small trades. This ‘flash-crash’ phenomenon has been exacerbated in the past couple of years as algorithmic trading has been gaining prominence.

 

Secondly, on what will be the focus of the rest of this article, that was the day Apple announced that its Q4 earnings would not be up to the mark and that investors should brace for disappointment. Apple has been one of the major drivers of the stock market gains over the past few years and thus this announcement was enough to send the stock crashing and investors scrambling to defensive or ‘safe haven’ investments, of which the Japanese Yen is a major one. The question arises: What makes the Yen a so called ‘safe haven’?

 

During the financial crisis and its aftermath, the yen appreciated by more than 20 percent. Later, in 2010, worries about peripheral European debt led to a 10 percent appreciation against the euro. A similar phenomenon occurred again in 2013 when uncertainty around Italian elections caused the yen to rise over 5% against the euro and 4% against the dollar … in a single day.

 

The reasons for this behavior are mainly attributed to two main factors. Firstly, Japan has always been a large exporter and has exported significantly more goods and services than it imports. The result has been years of current account surpluses that have placed Japan as a net creditor to the world.

This is a distinction also shared by Switzerland, whose swiss franc is

The value of foreign assets held by Japanese investors is substantially higher than the value of Japanese assets owned by foreign investors. These so-called “net foreign assets” stood at 339 trillion yen at the end of 2015, based on data from the Finance Ministry. The behavioral ramifications of this are simple: when markets become risk-averse, that money tends to move back home. This repatriation of capital coincides with a flow out of other currencies and into the Japanese yen, causing it to strengthen.

 

The second main reason is the so-called unraveling of a ‘carry-trade’. Japan has been a country with a low interest rate environment. Attempting to stave off deflation and spur economic growth, Japan has held interest rates at rock-bottom levels for nearly 20 years.

In what’s known as a carry trade, investors will borrow money in a low-interest rate environment and then invest that money in higher yielding assets from other countries. Japan’s long-standing policy of near-zero interest rates has caused it to become a major source of capital for these types of trades. During bouts of financial market volatility, investors would de-risk by shedding riskier foreign investments and cover their short positions in yen. This unwind of the yen carry trade would boost yen valuation, as asset managers sell foreign assets and cover their yen short.

 

As these fundamental factors have contributed to big institutional investors viewing the yen as a safe haven, this sentiment has been deeply entrenched in the markets. Investors around the world have come to embrace the yen as a reliable place to go for safety, and by attempting to take advantage of this, they actually create the intended effect. If you know that whenever the world panics, the yen is going to rise, then it makes it a no-brainer to buy the yen even if you’re unsure exactly why everyone else is.

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