Investors made a run for haven assets, such as the Swiss franc, gold and the Japanese yen, last week as tensions between North Korea and the U.S.came to a head. The pressure seems to have abated for now, but analysts warn they could spike again at any time, raising the question of how safe traditional havens really are.
The yen's go-to status as asset -- a position that currency has maintained in some investor minds since the early 1990s -- might be shaky if the diplomatic crisis graduates to a military conflict, market participants said.
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As a neighbor to the rivals sharing the Korean Peninsula, with only the Sea of Japan between them, Japan might find itself on the frontline of any military faceoff between Pyongyang and the U.S. It is also home to U.S. military bases, making it a potential strategic target. Besides the physical fallout, a war would have repercussions for the Japanese economy, Kuniyuki Hirai, head of FX trading at MUFG said.
"If armed confrontation materializes in North Korea and Japan would be attacked ... there is no sense that the yen would strengthen," he continued. "The yen may outperform the South Korean won, but the current [trading] situation might be a bit exaggerated or overestimate the yen's strength."
Given that, the yenmight not maintain its traditional status as a haven asset, and could weaken in the event war breaks out in the region, according to Neil Mellor, chief strategist at BNY Mellon.
The relationship between the Japanese currency and risk aversion is based on Japan's so-called current accounts -- a broad gauge of the country's trade in goods and services, including employee wages and income from investments. Country's like Japan tend to run current-account surpluses, meaning that their income from overseas trade exceeds payments to foreign entities.
Ultralow interest rates that have prevailed in the region also have made the yen an ideal currency for traders, with investors tending to take advantage of low rates in the region to borrow from and then to sell to identify higher interest-rate currencies elsewhere, in what is typically described as a funding currency.
In June, Japan reported its 36th consecutive current account surplus reading Yen935 billion and expectations of Yen860.5 billion.
For that reason, the Japanese yen has been a currency that has commanded almost reflexive haven bids from traders in time of crisis, even when that turmoil was in Japan.
It is a habit that might be hard to break, some strategist said. Aside from the funding currency, Japanese investors also tend to bring money home in times of trouble.
"At the time of [Japan's] earthquake [and subsequent tsunami] in 2011, the yen rallied against almost everything else. This kind of repatriation is typical, so there's a precedent here despite the geographical closeness [to North Korea] and the fact that Japan is home to U.S. military bases," Hirai said.
But equating a natural disaster and a war is a mistake, Hirai continued. Japanese insurance business have a lot of money invested abroad and repatriate their cash when it is needed for large scale insurance payments, like in the case of the 2011 earthquake, which accelerated the strengthening of the yen.
"[W]ar is a so-called force majeure in insurance disclaimers, and [they] have no liability to pay for the damage," he said.
Over the past week, the dollarweakened 1.4% against the yen, closing at Yen109.19 last Friday. On Monday, the greenback strengthened against all of its rivals (http://www.marketwatch.com/story/dollar-bounces-higher-as-north-korea-anxieties-take-a-back-seat-2017-08-14) as the geopolitical crisis made room for a domestic one following clashes of protestors in Charlottsville, Va. over the weekend. Still, analysts caution that the attention could shift back to North Korea quickly as the annual U.S. and South Korean military drills are on the calendar for later this month.
Another aspect of investors' leap to safety is that Japan's government is not too fond of the idea of a stronger yen because it would have a negative impact on Abenomics, the economic policies put in place by Prime Minister Shinzo Abe that are based in part on quantitative easing.
"We should be mindful that [a stronger yen] might lead to at least verbal intervention from the Bank of Japan," Mellor added.
Another way to play the traditional haven currencies could be to match them against one another, such as in the case of Swiss franc/yen . Both are considered a good place to put money in turbulent times, but given Switzerland's enormous geographical distance from North-East Asia, it could easily be considered more resilient compared to the yen.
Meanwhile, the South Korean wondropped 2% against the yen, closing at Yen0.096 on Friday before picking up some steam to Yen0.0962 this morning.
The South Korean wonwould, of course, suffer in case of a war as the nation would face physical confrontations along its Northern border. Yet, anybody convinced that a war is still unlikely could do well in buying won/yen options to take advantage of any strengthening of the South Korean currency if and when stability returns to the Korean peninsula.
"If there are any negotiations [with North Korea], the won would spike against the yen," Hirai added.
(END) Dow Jones Newswires
August 15, 2017 10:15 ET (14:15 GMT)