The Japanese yen is one of the world's pre-eminent safe haven currencies - typically expected to strengthen in times of market turmoil. So why has it performed so poorly in the face of the U.S. and Israel's war with Iran?
Japan's huge trade surplus and enormous net international investment positions once made the yen one of the FX market's premier bolt-holes during times of market trouble. These days, the yen's safe-haven status appears much more conditional.
The yen "can be vulnerable to potential oil supply shocks – it also weakened last year in mid-June amid Israel-Iran tensions", said Joey Chew, head of Asia FX research at HSBC.
With China and others swiping market share from the country's exporters, energy imports rising to offset lost supply from Japan's fleet of nuclear power plants idled since the Fukushima accident, and interest rates no longer providing a reliable anchor, the yen's fundamentals have changed substantially.
As the yen hovers just below 160 per dollar - its weakest levels since the last intervention to strengthen the currency in July 2024 - investors are wary of a fresh action from Tokyo.
The yen "is very exposed to oil prices" and "on a further oil shock it could readily break 160," said Steve Englander, global head of G10 FX research at Standard Chartered.
"Investors shouldn’t bank on the yen returning as a safe haven during the current crisis," said Thomas Mathews, head of markets for Asia-Pacific at Capital Economics in Wellington. "But it doesn’t mean the yen’s safe-haven status is gone forever," he added.
As Carol Kong, currency strategist at Commonwealth Bank of Australia in Sydney, puts it, the longer the war drags the more it will weigh on the global growth outlook. Those conditions would help the yen recover, she said.
The spectre of stagflation
Consumer prices surged globally after the Arab oil embargo during the 1973 Yom Kippur War. As oil prices tripled, Japanese inflation hit as much as 24.9% the following year, among the highest year-on-year increases in advanced economies.
Those stagflation worries from 1970s appear to be back in investors' minds.
Oil price impact
But the relationship between oil and the yen is far from stable, flipping from negative to positive and back again repeatedly since the COVID-19 pandemic.
Interest rates losing influence
The spread between Japanese and U.S. 10-year bond yields was once a reliable indicator of the yen's direction, but no longer. Whether spending by Prime Minister Sanae Takaichi's government or the BOJ's balance sheet activity is the driving factor is a matter of intense debate.
Yen shorts return
Traders are probing to figure out whether there is a line in the sand that authorities will defend. The latest weekly CFTC data show a growing net short yen position among speculative traders, a category that includes hedge funds.
Carry trades retain appeal
Dollar-hedged yen carry trades still appear surprisingly stable. After swapping local currency for greenbacks, JGB investors can receive a higher return than available in the Treasury bond market. But after a period of resilient demand, Japanese bonds suffered the sharpest weekly foreign outflow since mid-January in the week to March 7.
(Reporting by Gregor Stuart Hunter in Singapore, additional reporting by Ankur Banerjee; Editing by Sam Holmes)
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This article was written by Gregor Stuart Hunter from Reuters and was legally licensed through the DiveMarketplace by Industry Dive.