JPY: Geopolitical risk in East Asia – Deutsche Bank

Taisuke Tanaka, Strategist at Deutsche Bank, explains that yen, a creditor nation currency, tends to appreciate during risk-averse times and many questions have been raised over geopolitical risk in East Asia, a theme DB do not like do dwell upon lightly.

Key Quotes

“Forex markets in times of crisis generally go through three phases: (1) a reduction in risk positions and securing of liquidity; (2) pressure between debtor and creditor nations; and (3) a change in the fundamentals.”

“The movement in major currencies for ten days after the terrorist events in the US on 11 September 2001. There was a brief halt in some international financial transactions at that time, but forex markets continued to move. Currencies shifted virtually in order of their creditor and debtor positions versus other nations. The US was the victim this time. From the perspective of preserving global liquidity, the dollar could also rise depending on the nature and extent of the emergency.”

“In the case of East Asia, we cannot exclude the possibility of damage from preemptive or retaliatory attacks not only on Korea but on Japan as well. The conditions to consider are extremely wide ranging, as shown in the strategies presented in the many reported case studies. Let us consider the potential reaction in the yen in stages (1) and (2).”

“Many market participants will immediately recall the upswing in the yen after the devastating earthquakes of 1995 and 2011 as examples of large-scale damage in Japan. A widespread belief is that the yen was buoyed by repatriation of the currency for insurance payouts. However, currency flows for such insurance purposes were relatively small and, in any case, did not occur immediately after an earthquake.”

“In fact, the stubborn risk aversion of financial flows in creditor Japan puts upward pressure on the yen. This was exacerbated by speculative yen buying as well as special factors in 1995 and 2011, such as position adjustments and risk reduction, to generate an appreciation in the currency.”

“If a crisis materializes in East Asia involving Japan, we imagine this will provoke a disposal of Japanese assets by foreign investors and a selloff of the yen. However, we suspect that a plunge in Japanese stock markets would strengthen risk-off sentiment, recalling post-quake reactions for many market participants. Upward pressure on the yen could thus prevail, at least in the near term. To repeat, we do not consider such possibility lightly and hope fervently that no such crisis will come to reality.”