When markets go into a tailspin, there’s one figure above all others that currency investors look out for.
It’s not one of the regular drivers of exchange rates, such as interest rates, economic growth or even valuations based on differences in inflation. Rather, it’s a nation’s current account. All of the seven major currencies to have strengthened against the dollar in 2016 - led by the yen and including the euro, Swiss franc and Swedish krona - are those of economies that offer the stability of a surplus in the broadest measure of trade.
At times like this, the negative interest rates that several of those jurisdictions have adopted aren’t able to stop their currencies appreciating. They may even be contributing to the gains because loose monetary policy encourages investment in higher-yielding assets, deals which are now being unwound as markets become more volatile. That matters because a stronger exchange rate can hamper growth.
“The current-account-surplus countries are going to see their currencies under upward pressure until sentiment in risk markets can be turned around,” said Ray Attrill, co-head of currency strategy at National Australia Bank Ltd in Sydney. “We’re seeing the repatriation of capital to home shores from overseas - everyone’s scared and so we’re back in the return- of-capital rather than return-on-capital mode.”
The currency gains underline the challenges faced by nations that are net lenders to the world. While they’re not reliant on foreign money to finance themselves, they’re vulnerable to investment pouring in at precisely the wrong time, making their exchange rates less competitive and hurting exports, just as global growth is slowing.
Japan and the eurozone run current-account surpluses equivalent to about 3% of their economies, while Switzerland’s is 12.5% and Sweden’s 6.4%. All four have introduced negative rates. The euro area’s surplus is equivalent to net buying averaging about €25bn ($28bn) a month, according to Commonwealth Bank of Australia.
The yen recently posted the sharpest two-week gain since the Asian financial crisis of 1998. Both it and the euro have gained about 5% since their central banks cut borrowing costs - the Bank of Japan on January 29, when it introduced a negative interest rate, and the European Central Bank on December 3.
The franc has strengthened more than 1% since sliding on February 4 to the weakest level since the Swiss National Bank stopped defending its 1.20-per-euro cap from speculators in January 2015.
“The current level of the yen shows what happens when gamblers leave the scene,” said Daisuke Karakama, Tokyo-based chief market economist at Mizuho Bank Ltd. “The current-account surplus should be respected as mirroring real demand for a currency. The reason why the current-account surplus isn’t reflected in currencies unless it’s a crisis is because of speculative positions.”
Intervention to sell the yen would be unlikely to reverse the current trend, Karakama said.
In a sign cheap-to-borrow currencies such as the yen and euro may be being repatriated, returns on carry trades have tumbled in the recent market turmoil. Deutsche Bank AG’s Group-of-10 FX Carry Basket has fallen about 4.8% in 2016 in the worst start to a year this century and is approaching the lowest level since 2009.
“At a time of great uncertainty, money has a bias to come home,” said Kit Juckes, a strategist at Societe Generale SA in London.
Carry trades involve borrowing where interest rates are low to invest where yields are higher, and when they’re unwound the funding currency tends to appreciate. Volatility can wipe out the profit from the interest-rate differential, and a gauge of anticipated currency price swings peaked last week at the highest in four years.
“Japanese have an astounding amount of outbound securities investment, a real yen-short position,” said Tohru Sasaki, head of Japan markets research in Tokyo at JPMorgan Chase & Co, who predicted the currency’s decline in early 2015 and then said in December he expected it to gain to 110 within 12 months. “It’s an issue of repatriating them.”