All bets are off as the world markets digest the devastating earthquake and tsunami in Japan. Japan is still essentially the world second largest economy and the effect on her as a trading nation is far from clear. As a result expect high volatility and big changes in valuations in all the main investment groups over the coming weeks.
For instance the Japanese Yen made an unexpectedly large gain immediately after the earthquake. The Yen increased by nearly 2% against the Pound on Friday and about 1.5% against the US Dollar. There are two reasons for this. The first is natural risk aversion in the market place. There have now been major disasters in three of the largest world economies (Japan, Australian & New Zealand), major unrest in the Middle East and economic slowdown in the west all this year. As Paul Donavan from UBS put it in the Sunday Times ‘Investors haven’t seen this level of political risk for 20 years and they won’t know how to handle it’ – though the cynic may point toward 2008’s banking crisis & 9/11 as a comparable market mover.
The second reason for the surge in the Yen is the funding of the emergency and relief effort. Large governmental, charitable and supra national organisations are unwinding large positions in the market place to fund rescue and recovery operations. The majority of these investments will be Euro, Sterling & US Dollar denominated so explaining large changes in exchange rates.
The commodity markets are also affected because Japan is one of the single biggest importers of raw materials in the world. As the Japanese economy grinds to a halt demand for materials will drop, which impacts the currencies of South Africa, Australia & New Zealand. Oil prices are also falling, which will impact almost all currencies. Additionally the main London insurers Lloyds, Hiscox, Hardy & Caitlin will all have to unwind large positions- often with unlimited liability – which will have a massive impact on the markets. As Japan is also already creeping into recession, has recently had its credit rating downgraded, has some of the highest debt levels of a developed nation & has zero interest rates – her ability to loosen monetary policy is heavily restricted
The currency markets will this week respond to how bad the crisis gets. Of particular interest is the threat of meltdown at the Fukushima Daiichi nuclear power facility, 240km north of Tokyo. Expect large value swings and high volatility this week. A large sell off of risky assets is likely to dominate with the US Dollar and Japanese Yen expected to benefit. The Nikkei stock exchange is down by 6% today and the Bank of Japan has announced $265bn cash injection to stablise markets
Under normal circumstance market would look to the following data this week. The US Federal Reserve Open Market Committee decides on interest rates, which are likely to be unchanged. There is also US producer price inflation data released on Wednesday and industrial indices announced on Thursday. In the UK jobless data is released on Wednesday and the Public Sector Net Borrowing requirement is estimated on Friday, which will indicate how much leeway George Osborne has in his upcoming budget. Over the channel European economic sentiment date is released on Thursday as well as CPI inflation data on Wednesday.
As a footnote Legal & General Investment Management estimate that 9 in 10 of all mortgages in the UK are on variable rates. This is 10m of the 11.2m households with total mortgage debts of £1.2 trillion. Which means that homeowners (both residential and investment) are massively exposed in the event of a UK base rate increase. This may explain why the MPC refuses to increase interest rates despite inflation being double the Bank of England’s target.
