As we noted earlier on Friday, there’s nothing quite like a killer earthquake and tsunami to boost a currency — at least, that seems to be the case in Japan where the yen not only recovered after dipping in the wake of Friday’s 8.9-magnitude earthquake and massive tsunami, but went on to rack up some fairly astonishing gains.
In most countries, a natural disaster of that scale would drive a currency down, as seen in New Zealand, where the earthquake that devastated central Christchurch drove down the kiwi and prompted the central bank to cut rates.
Japan is only just starting to count the destruction and loss of life wreaked by Friday’s twin disasters – even amid fresh fears of faults at nuclear plants and possible aftershocks.
Even so, the resilience of the yen has taken even seasoned observers by surprise. In its Friday market update, Goldcore warns that market participants “appear to be seriously underestimating the risk posed by the megaquake to the Japanese economy and assets”.
Either way, many do not buy the simple theory that the currency has strengthened on expectations that companies will repatriate overseas assets.
BarCap’s Japan currency strategists say while it’s still too early to assess overall damage from the earthquake, the short-run effect: will probably be a positive for the yen, although some of the effect has probably already gone through the market. They continue:
The earthquake is negative for sentiment, which combined with other “risk off” factors (the Middle East, doubts about China’s economic growth, Europe), will probably create a modest bid for the JPY. On the margin, there will probably be some repatriation inflows, but what we have seen so far is probably speculative positioning in front of these flows, rather than the flows themselves.
The ultimate size of the repat will depend on the damage, and we do not have good estimates of that yet. For comparison, estimates put the damage from the Kobe earthquake at USD100-150bn; insurance claims were only USD6bn.
In the medium-term, however, the effect on the yen will not be “great”, they say.
Tokyo and other major population/economic centers were shaken, but not affected by the tsunami. Fiscal/monetary stimulus may fall short of what many expect (after the Kobe earthquake, output fell sharply, then outpaced national growth for the next year, but undershot national activity).
After the Kobe earthquake, USD/JPY initially rose, but this probably reflected Fed tightening (the rate hike in late January 1995) more than earthquake effects per se. In the next two months, of course, USD/JPY crashed, but it is worth noting that US monetary policy expectations made an about face (and the Fed cut in July 1995). Also, the Barings bankruptcy crashed the Nikkei, which forced huge repatriations. The Japanese financial system is probably less vulnerable to these disruptions now.
The Bank of Japan meanwhile has pledged to “ensure financial stability” in the wake of Friday’s disasters and has taken the unusual step of cutting short its two-day Policy Board meeting scheduled for Monday and Tuesday to just one day, and to conclude it within Monday.
As Bloomberg reports, the BoJ has already cut its benchmark rate to zero in an effort to end deflation, set up an emergency task force and has now said it will do everything to provide liquidity. It also announced on Friday afternoon that its settlement system was working and that it was able to settle all accounts smoothly within the day.
The obvious reason for the Bank’s unusually snappy pace, as Capital Economics says in a Friday note, is that the Bank “wants to bring forward the policy announcement to accommodate additional measures in response to today’s earthquake”.
The BoJ already promised in the wake of the disaster to do its “utmost, including the provision of liquidity, to ensure the stability in financial markets and to secure the smooth settlement of funds, in the coming week”.
But Capital Economics thinks it may go further, as it did after the Kobe earthquake in 1995, and introduce new special loan facilities to support reconstruction efforts in the areas most affected. It adds:
The Bank will also be watching the yen and will probably choose its words carefully to help prevent the currency from appreciating any further. New measures might be interpreted by the markets as additional quantitative easing by the Bank of Japan at a time when some other central banks are edging towards tightening policy. As we noted… earlier… the impact of the disaster on the yen could eventually go either way, but the Bank has an early opportunity to tip the balance towards renewed weakness.
Indeed, JPMorgan’s Masaaki Kanno also thinks the BoJ will expand its liquidity provision measures, especially if the yen strengthens further as it did in the aftermath of the Kobe quake.
It is possible, he says, that, if USD/JPY plunges, and the Nikkei is sold off heavily on Monday, the BoJ will increase the amount of, or accelerate the pace of its purchase of Japanese government bonds, within the framework of its current asset purchase programme.
Speaking of comparisons with the Kobe quake, which at magnitude 7.3 was much milder than Friday’s quake (and did not bring with it a tsunami, although it did cause 6,400 deaths), Richard Jerram of Macquarie Securities makes the following points:
Japan improved its disaster response systems in reaction to poor performance in the aftermath of the Kobe earthquake, and disruption from the 2004 Chuetsu earthquake was limited. The BOJ has systems in place to provide liquidity if necessary.
Miyagi (home to Sendai and the most affected by the quake) accounts for 1.7% of the population and the same proportion of GDP. Tohoku as a whole is abut 8.0% of GDP. Initial reports suggest that Tokyo has not been badly damaged (Kanto accounts for nearly 40% of GDP). By contrast, Kobe made up almost 4.0% of GDP and the importance of its port and its geographic position between Osaka and Western Japan meant that the disruption was significant.
There are two basic economics-related concerns. The first is that the fragile economic cycle is not in a position to withstand significant disruption. The second is that the combination of a softer economy and the additional strain on public finances will put upward pressure on bond yields.
Related links:
In-depth report: Japan earthquake – FT.com
Earthquakes – from Japan to the States and back – FT Alphaville
Japan’s earthquake markets, then and now - FT Alphaville
Monetary policy in a time of natural disaster - FT Alphaville