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Yen Outlook Dims as Scope of Japan's Disaster Expands

As J

Damaged houses, cars and debris after the earthquake
Sankei | Getty Images
Damaged houses, cars and debris after the earthquake

apan's earthquake-tsunami damage grows, the effects are rippling through the financial markets, and currency traders are reassessing the impact of the disaster on the yen.

When the quake first hit, traders were generally bullish on the yen, comparing its prospects to those after the 1995 Kobe earthquake. But investors are now finding flaws in that comparison, and recalculating just how much money will be coming back into the country in the form of insurance payments and risk-averse repatriation.

After the Kobe earthquake, the yen eventually rose to record levels against the dollar. But at that time, the dollar was facing headwinds of its own that helped it weaken against the yen, like the Mexican peso crisis. Also, insurance companies quickly sold foreign assets after the Kobe quake. Analysts expect repatriation now as well, but Jens Nordvig, global head of G10 FX strategy at Nomura Securities, estimates that cross-border flows "are unlikely to exceed $10-15 billion, and will be spread out over time."

Most important, Japan has a huge incentive to keep the yen from strengthening. Japan needs to keep exporting in order to get its economy back up on its feet, and a strong yen would make that tough. The Bank of Japan has already demonstrated its willingness to intervene in the money markets with a massive liquidity injection earlier today. Nomura, for one, thinks dollar/yen could be slightly weaker than its published forecast, and allows that "there is now some downside risk" to its forecasts, and a chance that dollar/yen could slip below 80, but it is sticking with targets of 85 by the end of the first quarter and 87.5 by midyear.

One thing is clear: Japan is contending with a massive disaster, and recovery on the ground and in the currency markets is likely to be choppy. If you take a position on the yen, be prepared to adjust quickly - or take the long view.

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