First reaction – risk appetite went out of the window and risk aversion came to the fore. This meant that currencies viewed as more risky, usually those correlated with the emerging countries or having higher interest rates, lost ground.
Industry in Japan was clearly going to be affected given the extensive damage from the earthquake and tsunami. We also have the problems with the nuclear reactors leading to a shortfall in power supplies. And what would the knock on affect be for other countries in the world? Japan is an important exporter of goods and parts and as such, businesses elsewhere in the world could suffer.
The commodity backed currencies were the first to suffer with the Australian and Canadian dollars and the South African rand losing ground. Not surprising, as they are very dependent on growth continuing in the emerging markets, especially China. It also has to be remembered that Australia suffered its own natural disaster in the first part of this year. Floods in Queensland brought both the production and export of minerals to a halt.
Then the yen started to strengthen. Slightly strange reaction, but the logic was that Japanese investors would have to sell their overseas assets and repatriate funds so as to pay for the rebuilding work that is required. Following the Kobe earthquake in the 1990s, the Japanese yen strengthened by 15 percent over the next six months.
But the same scenario this time would create a serious problem as the Japanese Yen was already too strong and had been hurting Japanese exports even before the earthquake and tsunami. So, when the yen started to strengthen, a decision was taken by the central banks of the seven largest economies [e.g. the USA, Germany] to sell the yen. This immediately caused the yen to weaken and forced the speculators to run for cover.
Risk aversion usually benefits the Swiss franc and the US$ as investors view these as same haven assets. This time around the Swiss franc has strengthened as expected. However the US$ has lost ground. The major influence seems to be the oil price which is dependent on the unrest in the Middle East. As the oil price goes up, the US$ loses ground and as the oil price goes down, the opposite happens. Very simple, but the correlation has remained strong even with the problems in Japan. One of the beneficiaries of the uncertainty seems to have been the euro. This has been one of the top performing currencies over the last few weeks, even though the government and bank debt problems of the euro zone are far from being resolved. Germany continues to grow at a greater rate than most countries, which is very important for euro zone stability. The European Central Bank has also raised its concerns about above target inflation and the need to get on top of this as soon as possible.
The market interprets this as meaning that euro zone interest rates will be increased sometime very soon. This would be the first increase from amongst the UK, the USA and the eurozone and is very supportive for the euro.
Here in the UK, the problems of reduced growth and the austerity measures beginning to bite have been at the forefront of peoples’ thoughts economically. The one major affect of Japan’s problems was the revision to the markets views as to when interest rates in the UK would be changed. UK inflation continues to stay high and the way to combat this is to increase interest rates. Prior to the Japanese disasters, the expectation was for an increase by May of this year of 0.25 percent with two further increases by the end of the year. The view now is that we will see an increase in August with perhaps one further increase later this year. This has led to a fall in support for sterling.
And what of the commodity backed currencies that were first affected by the Japanese disaster? Well these are now back in the ascendancy as the problems in Japan seem to have stabilised for the time being. We have seen the Australian dollar hit all time highs against the US$ and gain over five cents in just over five days against sterling, returning to the trends of the last two years.
This highlights how quickly things change in the world of currency when, after three or four weeks, the affect to this monumental disaster on exchange rates has reduced significantly as other news has come to the fore.
Charles Purdy is a Director at Smart Currency Exchange, the internal payment specialist (www.SmartCurrencyExchange.com, 0207 898 0541).
