Photographer: Tomohiro Ohsumi/Bloomberg

Here's What a North Korea War Might Mean for the Yen

  • Strategists see initial appreciation when tensions escalate
  • Key question is whether Japanese repatriate their capital

What happens to the yen if war breaks out with North Korea, pulling Japan into the conflict?

It’s a question that market players are starting to mull over, as tensions escalate over the dictatorship’s efforts to build an arsenal that can deliver a nuclear bomb to the U.S. -- Japan’s top ally. And there’s no fundamental agreement on what happens in the worst-case scenario.

"Beyond the immediate aftermath, the trajectory for the yen is much harder to call," said Yuki Masujima, an economist at Bloomberg Intelligence in Tokyo. Tomo Kinoshita, chief market economist at Nomura Securities Co., explained that “this is quite a difficult issue to analyze, because there are a lot of uncertainties," ranging from what Japanese investors would do and what the situation would be in the U.S. and prospects for its own economy.

What Kinoshita and several long-time Japan analysts do agree on is the yen is set to keep appreciating on bouts of higher tension. At 108.70 per dollar late Wednesday in Tokyo, it was up 7.6 percent for 2017. That’s in keeping with the currency’s safe-haven status, stemming from Japan’s massive net credit position, the world’s largest.

Where the experts disagree is the yen’s path in the scenario of an actual outbreak of hostility. Here are some of the lines of thinking:

  • Traders who borrowed yen at Japan’s rock-bottom borrowing costs to invest in higher-yielding currencies would quickly unwind their positions, sending the currency higher in a knee-jerk reaction
  • Foreign investors, who hold about 30 percent of Japan’s stock market -- some 175 trillion yen ($1.6 trillion) as of the end of March -- would pull funds out, spooked by fears of damage to the nation from an attack and the hit to corporate earnings
  • Japanese themselves would take money out of the country, for the same reasons as foreign stockholders
  • At the same time, Japanese insurers and manufacturers would bring overseas funds back home to pay for domestic damage
  • Treasury yields fall as investors seek safer assets, causing the dollar to weaken and boosting the yen
  • Expectations for U.S. defense spending improve prospects for American growth, strengthening the dollar and driving down the yen

“The initial shock of yen appreciation would probably be extremely strong," said Daisaku Ueno, chief foreign-exchange strategist at Mitsubishi UFJ Morgan Stanley Securities in Tokyo. "It wouldn’t be a surprise if we saw it surging by 8 yen or so," as it did the day of the shock Brexit-vote result last year, he said.

But speculation of a possible capital exodus out of Japan would then see dollar-yen reverse, according to Ueno. “After an 8 yen appreciation, dollar-yen could rebound more than 10 yen or even double” the initial move, he said.

Kinoshita at Nomura echoed that assessment, saying “the yen would react rather sharply" if military action took place involving Japan. “The outflow of funds would mean depreciation in the Japanese yen."

That clashes with the assessment of Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo, who two decades ago served in the Bank of Japan’s foreign-exchange division. He invoked the example of the March 2011 devastation in northeast Japan from the powerful earthquake and tsunami that hit the Tohoku region.

“If the damage from North Korea were greater than the Tohoku earthquake, then Japanese investors eventually would unwind their positions and bring back funds from abroad," Sasaki said. “The more damage to Japan, the more appreciation of the yen."

Key to Sasaki’s view: Japanese investors’ net foreign holdings at the end of last year were $3.1 trillion, or more than 60 percent the size of its entire economy, giving them an unrivaled pool of capital to draw on. China is the second-largest net creditor.

“Some investors may speculate that the yen would depreciate in the case of a North Korean attack -- but if there’s an attack, the whole world would be in a state of upset -- what speculators would be there to take such positions?" Sasaki said.

How any conflict actually transpires could also change the equation for the yen. Hidenori Suezawa at SMBC Nikko Securities Inc. in Tokyo, sees a military clash benefiting the yen unless a missile actually hits Japan and causes damage, triggering capital flight. Though he placed low probability on that scenario.

What Suezawa and the other experts do agree on: the yen will remain strong as long as tensions surrounding North Korea are in place and don’t directly impact Japan.

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