Foreign exchange markets reflect such a diversity of views that they can often do baffling things. Yesterday’s moves in dollar/yen are a good example.
One story doing the rounds since Japan’s devastating earthquake and tsunami last Friday is that the yen will inevitably rise as Japanese insurers sell their foreign currency to repay all their yen liabilities. And, sure enough, the Japanese currency rose after the disaster struck, proving to some that the repatriation trade was on.
As it turns out, none of this is true. “Today’s move had nothing to do with that,” said Eric Schatz, head of foreign exchange at Barclays Capital in Tokyo. “There’s no money coming back for repatriation.”
Japanese insurers are well-hedged at about 70% and have huge holdings in government bonds, which they could easily sell if they needed yen. And the industry is reinsured by the government anyway, so there is no shortage of yen in the insurance market.
The repatriation trade is, at best, premature, but the rumour of its existence was enough eventually to tip the market into a forced sell-off yesterday as dollar/yen sank below 80.
Mrs Watanabe, the archetypal Japanese housewife, typically holds a long position in US dollars. By Tuesday, those positions reached an all-time peak and, with dollar/yen parked close to 80, foreign speculators anticipating repatriation flows started to sell in the early hours of yesterday morning as trading moved from New York to Tokyo and liquidity was exceptionally low.
Around the ¥80 mark, corporate options structures knocked out and led the initial selling before retail exchanges opened at 7.15am. By that time, retail investors’ long dollar positions had built up a substantial backlog of stop-loss orders, driving dollar/yen down to a record low of 76.36. According to Deutsche Bank, 80% of sellers during the day were retail – not insurers.
At that point, some in the market expected the Bank of Japan to stabilise the currency, but the central bank pressed instead for a coordinated intervention plan with G7 countries, which they agreed this morning.
“The yen has overshot the market and is overvalued, so intervention is justified,” said Tomoo Onishi, head of FX sales at Deutsche Bank in Tokyo, before heading home to a rolling blackout last night.
That support should help the yen return towards fair value, which Deutsche Bank says is 95, but during the vacuum yesterday the central bank’s inaction only encouraged the sellers.
Even so, the market sorted itself out in the end, to some degree, when another group of Mrs Watanabes, who were watching the yen’s appreciation from the sidelines, stepped in to sweep up the cheap dollars.
As much as yesterday’s story was about retail investors, uncertainty is the underlying cause of the market volatility. Much of that stems from a perception that the Japanese government is not being as open as it could be about the situation at the Fukushima nuclear complex, but Schatz said that this is unfair: “It might not always have been the case in the past, but they’re trying to be as transparent as possible.”
