Why the yen remains a haven

By Lindsay Whipp in Tokyo and Peter Garnham in London

Economic weakness is no barrier to a strong currency these days. Just ask Japan.

The yen stormed to a series of multi-years this week, hitting a 13½ year high against the dollar, a seven-year peak against the euro and a record high against sterling.

This is despite the fact that Japan’s export-dependent economy continues to suffer from the global economic downturn. The Bank of Japan warned this week that the country could expect its economy to contract in the current fiscal year, ending on March 31, and the next one.

But rapidly deteriorating economic data, including a record drop in exports for December, and a lengthening list of exporters expecting steep annual losses has done nothing to weaken the country’s currency.

One reason for this is that the yen is seen a safe-haven at a time of extreme nervousness in global markets and when the US, eurozone and the UK are all in recession or heading there.

Analysts say the yen is benefiting from increasing concerns over the spillover from the credit crisis to the financial system, which has seen financial shares in Europe and the US come under renewed pressure this week.

Muneteru Togawa, a director in the foreign exchange department at UBS in Tokyo, says although Japan’s banks have suffered from subprime losses, their exposure is on nothing like the scale of their European and US counterparts.

“Japanese banks appear not to have a bad loan problem and be weighed down by subprime debt, so the yen has been chosen as a safe currency,” he says.

Indeed, the yen has displayed an increasingly negative correlation with equities in recent days, moves that echo the sharp rise in the yen in the wake of Lehman collapse last September.

In addition, the yen has benefited from the global deleveraging prompted by the intensification of the financial crisis.

This rise in risk aversion has seen the continued unwinding by international investors of carry trade positions, in which the ultra-low-yielding yen is sold to finance the purchase of riskier, higher-yielding assets elsewhere.

Deleveraging by domestic investors has also boosted the yen.

Japan has been a low interest-rate country for so long that domestic investors have sought higher yields overseas.

However, as global asset markets fell and central banks around the world slashed rates towards ultra-low Japanese levels, Japanese retail investors have hurried to repatriate investments back to their home currency.

Indeed, margin trading of the yen against the dollar and euro during Tokyo hours by retail investors is estimated to account for more than 10 per cent of the market, underscoring the importance of these so-called day traders.

The strength of the yen could not have come at a worse time for Japan’s exporters. Global demand is slumping and the stronger yen, which makes Japanese products more expensive and eats into repatriated earnings, has generated shocks such as Toyota’s announcement it was likely to post its first loss in 70 years.

When the dollar slid to fresh 13-year lows of Y87.10 against the yen earlier this week, discussions about the possibility of intervention by Japan’s Ministry of Finance increased.

Shoichi Nakagawa, finance minister, told reporters on Friday that he was watching the currency movements closely and would take steps as necessary.

Many traders remain convinced that intervention will remain verbal at most, while currency movements are not severely volatile, but that sudden swings or extremely rapid movements might prompt action. Japan has not intervened in currency markets for five years.

Derek Halpenny at Bank of Tokyo-Mitsubishi UFJ says he expects Japan to intervene to buy dollars against the yen if the greenback lurches down through Y85.00.

“There must be an increasing risk that the authorities are growing concerned – especially about the deflationary impetus from a surge in the yen,” he says.

Eisuke Sakakibara, Japan’s former vice-finance minister, once universally referred to as Mr Yen, and now a professor at Waseda University, told the Financial Times in an interview that intervention was a possibility.

“I think toward the end of March, Japanese government, with the agreement of the American Treasury, would intervene,” Mr Sakakibara said. “And they will probably intervene between Y80 and Y85.”

Others are not so convinced.

“The economic situation is so dire and evenly spread globally, that I don’t think it would be appropriate to favour one country over another by allowing a unilateral weakening of the yen and think there’s a broad agreement on that,” says Glenn Maguire, chief Asia economist at Société Générale.

However, some analysts say the actions of the new US administration could hasten the yen’s rise.

Tim Geithner, president Barack Obama’s choice for Treasury Secretary, accused China this week of “manipulating” its currency and said the administration would use “all the diplomatic avenues open” to push for change.

Ashraf Laidi at CMC Markets said dollar/yen would come under prolonged downside pressure if the Obama Administration pressures China into further currency revaluation.

“The dollar/yen exchange rate would make the transition from ‘falling’ to ‘collapsing’,” he says.