Busch: Risk-Off Revisit


Back on February 22nd, I warned and predicted the start of a "Risk-Off" danger zone for the financial markets.

"The global financial markets are beginning to show signs of distress and volatility after an exceptional strong rally in US equities and global risk. The market narrative is shifting from a positive discussion on earnings and a US recovery to a negative conversation over global inflation, fiscal imbalances and political turmoil. This shift should mean uncertainty will rise and investor sentiment will pullback in reaction to this unstable environment....This will generate demand for safe haven investing like buying US Treasury securities and selling global equities. "

Now before I get too full of my predictive capabilities, I also thought the US dollar would be initially mixed as there wasn't a clean play to be had. This was somewhat true, but the situation in Japan and the subsequent substantial strengthening of the yen has been confounding. While we await the outcome of the nuclear disaster in Japan, we could be witnessing a structural change in the global financial markets.

The US dollar began the crisis at 83.0 and today has traded as low as 76.25, an all time low. While the currency markets were anticipating a repatriation of yen to Japan from insurance companies making payments, this amount would be relatively small compared to the overall yen move. A provider of risk modeling software for the Japanese insurance industry, AIR, estimates insurance claims related to the earthquake will range from only $15 to $35 billion. Then why has the yen strengthened so quickly? My theory is that panic, fear and Risk-Off remain the dominant factors despite what pundits say. If you are a Japanese corporation, your first instinct is to ensure you have cash available for on-going operations. In a disaster of unknown proportions, you have to err on the side of extreme liquidity and that means building up cash positions in your domestic currency. This translates into selling any security you own outside of Japan and bringing it back home.

We won't know if my theory is correct until we see the balance sheets from Japanese companies at the end of the quarter/year end. However, this was the pattern in the United States and you could argue it remains in place to this date. This means we have seen and will continue to see a profound shift in the structure of Japanese balance sheet management. It should lead to creation of large, persistent cash balances.

This would mean Japanese companies would decrease their demand for foreign financial assets and increase their demand for Japanese cash-like securities or simply cash. Barring G7 intervention, this would imply that yen strength is likely to last longer than most expect.

Andrew B. BuschDirector, Global Currency and Public Policy Strategist at BMO Capital Markets, a recognized expert on the world financial markets and how these markets are impacted by political events, and a contributor to CNBC's Money in Motion Currency Trading.You can comment on his piece and reach him hereand you can follow him on Twitter at http://twitter.com/abusch.

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