Currency Exchange Shock After Disaster In Japan

The natural disaster in Japan has sent shock waves through the world’s financial markets, sending investors scurrying in search of so called “safe haven” assets. Predictably, this meant traders selling out of Aussie dollar holdings and reverting instead to the relative safety of larger currencies like the US dollar, and perversely, the Japanese Yen! In times of crisis investors tend to repatriate assets, but in this case the repatriation flows are exacerbated by investors who borrowed Yen in order to fund bets on higher yielding currencies. As they sell out of currencies like the Aussie dollar, they buy back the borrowed Yen, driving its value higher. Previous bouts of weakness for the Aussie dollar have tended to be short but severe, so we could see continued weakness over the next few days if the situation surrounding Japan’s nuclear facilities does not improve.

The Bank of England held interest rates at a record low of 0.5% last week as expected. This still produced a mild negative reaction for Sterling as some investors were holding the Pound in the hope of a surprise hike. When it didn’t come they sold Sterling. We will have to await the minutes of the BoE meeting (due for release next Wednesday morning) to see how the nine member committee voted. The chancellor is also due to present the 2011 budget on the same day.

The foreign exchange rate market has been relatively devoid of key economic data so far this week. Construction of new houses in Australia declined 5.3% in the last quarter, far more than the 1.1% decline expected. The market all but ignored this piece of information. This morning we have wage growth data in the UK which will be keenly watched for any sign that inflation is putting upward pressure on wages. So far that hasn’t been the case, and has been one of the only reasons not to raise interest rates.

The technical outlook is mixed. Sterling is at the top of its range. It has tended to retreat from these levels over the last few months, but given events in Japan, weakness in high yielders could see Sterling break upwards out of its range. Buyers of the Aussie dollar should strongly consider buying half of their requirement at current levels to benefit from the recent upside, while looking to cover the balance at higher rates if the current spike continues.