Don’t compare Sendai quake to Kobe, Nomura FX analysts say

Recent exchange action between the Japanese yen and the US dollar:

It’s a tangled currency web woven largely by insurers.

Risk modeller AIR Worldwide said over the weekend that insured losses could be $14.5bn to $35bn, which excludes some pretty devestating tsunami effects. So you’ve got inflows from (largely European) reinsurers. Meanwhile Japan’s domestic insurers will probably have to liquidate some of their assets to make payments too.

These two combined mean more yen inflows. (Though there’s also a degree of repatriation risk from non-insurance investors, especially in equities). And currency traders seem to very much remember what happened after the Kobe earthquake in 1995 — when the yen strengthened against the US dollar in the months following.

However, perhaps we shouldn’t be extrapolating too much between the two events.

From Nomura’s currency analysts led by Taisuke Tanaka:

Difference with yen strengthening following Kobe earthquake in 1995: Many people have asked us how the latest disaster compares with the Kobe earthquake in 1995. In 1995, the yen strengthened sharply in the three months after the earthquake. USD/JPY ultimately broke below 80 to a record low. The economies of Iwate, Miyagi and Fukushima prefectures that have been affected most seriously this time account for 4% of GDP, about the same scale as the Hyogo Prefecture economy that was devastated by the Kobe earthquake in 1995. That said, the damages to infrastructure in the latest earthquake are more widespread owing to the effect of the tsunamis, which also aggravated the human toll. Our economists expect the short-term economic effect this time to exceed that in 1995, which we think will strengthen the yen by making investors less likely to take risk.

However, we do not think the main driver of the strong yen in 1995 was flow triggered by the earthquake. A sharp increase in US interest rates in 1994 led to crisis in Mexico and uncertainty in the dollar. In Japan, risk tolerance declined, and because US-Japan trade negotiations were in their final stages, there were strong underlying concerns about yen appreciation. In addition, life insurers and other Japanese entities accelerated the hedging and selling of assets denominated in foreign currencies (also owing to accounting issues; insurance companies had to record their mark-to-market losses once the losses exceeded 15% and they rushed to sell foreign bonds before the losses exceeded 15%), contributing to the yen’s sharp appreciation between the earthquake and the end-March book-closing period. The BOJ lowered interest rates in April 1995 in response to the strong yen.

That said the Nomura analysts still seem to be forecasting yen appreciation in the short-term following the 2011 Tōhoku quake — though, like many others, they figure the Bank of Japan will intervene if things get too hairy:

Intervention in response to yen appreciation possible over the short term: The destruction from the latest earthquake is likely to have the effect of strengthening the yen. The backdrop to the dramatic yen strengthening that occurred in the wake of the Kobe earthquake is different this time. However, USD/JPY remains strong at around 82 despite higher interest rates in the US (a weak yen factor). As the earthquake overlaps with the period prior to the end of the financial year for most companies in Japan, when investors can be jittery, we see the risk that the slight strong yen bias emanating from the latest tragedy could provide the impetus for USD/JPY to break through 80.

USD/JPY continues to be supported by recovery in the US and global economies, and we think it will weaken to the mid-80 to 90 range over the medium term. Over the short term, the strong yen bias could increase, but we think authorities are more likely now than before the earthquake to intervene. If a negative chain reaction were to occur in which the damages from the earthquake lead to a further strengthening of the yen, Japanese authorities would likely be justified in taking action to stem the yen’s appreciation. Unlike normal times, we expect that US and European authorities become more torelant to Japanese intervention. By supplying ample liquidity in concert with intervention in the foreign exchange market, we think the BOJ would be able to maintain a cooperative stance with its partners by not sterilizing funds used in the intervention in the short term.

The yen is currently at about 82 to the US dollar, and the Bank of Japan has just announced it will double its asset-buying pool to 10,000bn yen.

Related link:
Is BoJ-bashing about to inflate the world? - FT Alphaville