Resurgent Yen a Global Destabilizer

Once again, volatility favouring the Japanese Yen is having a pronounced effect on what happens in the stock market. There is a well documented history of the relationship that exists between global stock markets and the Yen. There appears to be a well-defined negative correlation between the yen and equity markets. When the yen surges, markets fall, and vice versa.

We have covered this topic on several occasions during this year:

  • The Carry Trade and Markets? What is the relationship?,
  • Resurgent Yen is Scary News,
  • Why the selloff in commodities and emerging markets?,
  • More Carry-Trade commentary
  • More volatility coming and more ETF options
  • Yen’s Strength [has been] profoundly negative for global markets

From the Economic Times, The Group of Seven issued warnings on Monday the yen's wild swings are threatening financial stability, fanning speculation central banks may intervene to halt a rally in the currency driven by a Japanese exodus from emerging markets.

The yen was the only currency mentioned in a brief G7 statement as it rallied to 13-year high against the dollar, not only threatening Japanese exports as the world's second-largest economy tumbles toward recession amid the worst global financial crisis in 80 years, but leading to a destabilization of currency related transactions that need to be unwound.

As a matter of background building, we provide below a summary of milestones in the yen's history:

1871 - The yen became Japan's currency as part of the Meiji Restoration, which marked the start of Japan's modernization and opening to the rest of the world. Japan adopted the gold standard.

1949 - After World War Two the dollar's fixed rate is set at 360 yen via the Bretton Woods system, partly to help stabilize prices in the Japanese economy.

1959 - The dollar/yen exchange rate is liberalized and the margin of fluctuation is set at 0.5 percent on either side of its dollar parity.

1963 - The margin of fluctuation is widened to 0.75 percent. 1971 - United States abandons gold standard, bringing an end to the Bretton Woods system of fixed exchange rates and forcing a realignment of world currencies.

December 1971 - Under the Smithsonian Agreement, the dollar/yen exchange rate is set at 308 yen and is allowed to fluctuate in a wider band between 301.07 yen and 314.93 yen.

1973 - Japanese monetary authorities decide to let the yen float freely against the dollar, and the yen appreciates as far as 263 to the dollar.

1978 - The yen pushes through 200 to the dollar for the first time, strengthening as far as 177.

1980 to 1985 - The yen's appreciation halts and partially reverses despite Japan's big trade surpluses. Higher interest rates in the United States prompt Japanese investors to put money in dollar assets.

1985 - The Group of Five industrial nations, the predecessor to the G7, sign the Plaza Accord in which they agree the dollar is overvalued and to weaken it. The yen climbs from its pre-accord level of around 240 to 211 in October and 200 in November, a 20 percent rise in just a few months.

1986 - The U.S. currency falls further to around 190 yen in January, 167 yen in April and 153 yen in August.

1987 - In February, six of the G7 nations sign the Louvre Accord, which aims to stabilize currencies and halt the dollar's broad decline. The dollar still falls from near 153 to 137 in April and 120.80 by the end of the year.

1988 - On January 4, the dollar falls to a post-war low of 120.45 yen in Tokyo trade, a level that holds as the low for more than five years. The Bank of Japan intervenes to buy dollars and sell yen that day on behalf of the Ministry of Finance.

August 17, 1993 - The dollar declines to a new post-war low of 100.40 yen in Tokyo.

June 21, 1994 - The dollar falls through the key 100 yen level and touches a record postwar low of 99.85 yen in New York trade before finishing at 100.30 yen.

April 19, 1995 - The dollar hits a record post-war low at 79.75 yen after U.S.-Japanese trade frictions spark heavy selling. By the end of the year it is near 103.40.

June 17, 1998 - As the dollar shoots above 144 yen, U.S. authorities join the Bank of Japan to buy yen, spending $833 million. By August the dollar rises to near 148 yen, partly due to yen carry trades in which investors borrow yen funds at Japan's near zero interest rates to buy higher-yielding currencies.

1998 - After the global financial market strains from the near collapse of hedge fund Long-Term Capital Management, carry trades are unwound quickly. In one week alone in October, the dollar tumbles from near 136 yen to a low around 111.50 yen.

1999 - The yen strengthens further despite repeated intervention, reaching 102 in November.

2001 - Following the Sept 11 attacks, Bank of Japan intervenes to sell yen for dollars.

2003 - The MOF begins massive intervention to halt the yen's rise against the dollar, partly to shield Japanese exporters as the economy remains stuck in its post-bubble slump and deflation. The MOF spends 20.4 trillion yen ($200 billion) over the year, nearly all of it to buy dollars and sell yen.

2004 - The MOF spends 14.8 trillion yen ($145 billion) intervening in the first quarter of the year, including 1.67 trillion yen buying dollars on January 9 alone. But the MOF ceases intervention in March and has never since resumed.

2005 - The yen reaches a high of 101.67 yen in January but then starts to fall, hitting 121.40 in December. Yen carry trades and Japanese investors shifting funds into foreign assets drive the slide.

June 2007 - The dollar hits a 4-1/2-year high of 124.14 yen. July 2007 - The yen's broad depreciation takes it to a 22-year low on a real effective exchange rate basis. Since January 2005 the yen has lost 25 percent of its value on a REER basis.

August 2007 - Strains in financial markets from the U.S. subprime mortgage crisis spark an unwind of yen carry trades.

The dollar falls from near 120 yen to 111.60 yen. The high-yielding Australian and New Zealand dollars tumble nearly 10 percent.

March 13, 2008 - The yen hits an 12-year high of 99.77.

October 24, 2008 - Yen hits 13-year high of 90.87 versus the dollar, while setting an all-time high against the Australian dollar of 55.11, with the Aussie losing almost a third of its value in just a month on a massive unwind of carry trades.

October 27, 2008 - The yen's surge to 13-year highs prompts the G7 to issue statement to single out the yen in warning on currency market volatility.

The yen has surged nearly 20 percent so far in October on a trade weighted basis, more than twice as big as any month going back to 1970, including the carry trade collapse in October 1998 and the Plaza Accord to weaken the dollar in 1985.

(Sources: Reuters, Bank of Japan, Bank of England)

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