Investment April 2011

Effects of Earthquake on the Australian Dollar and Yen

Japan’s importance to Australia is undoubted, as it is the country’s second-largest market after China, taking 19% of exports. Disruption to Japan’s economy might, therefore, be seen as a short term negative for Australia. However, the inevitable rebuilding of affected regions and infrastructure will boost demand for Australia’s commodities. Indeed, with some of Japan’s nuclear power plants damaged, Australia is likely to see a sharp rise in demand for major exports: alternative energy sources, such as thermal coal and liquefied natural gas.

In short, we don’t see the effects of the earthquake and tsunami as a negative for Australia and its dollar over the medium-term, but quite the opposite.

We remain comfortable with a long Australian dollar/yen position being a preferred medium-term trade with a 3-6 month target of ¥90.00, even if it remains volatile for now. This could provide opportunities to buy on dips, even after the recent G-7 statement affirming intervention to weaken the yen.

While we are sympathetic to the view that the earthquake is dollar/yen negative [stronger yen] in the very short-term as Japanese investors adopt a typical repatriation approach and there is some reversal of carry trades, the bigger picture is very different.

We expect downward pressure on the yen [higher US dollar/yen rate] to emerge as soon as the devastating events have forced Japan’s main political parties to finally agree on further deficit spending. We anticipate such largesse will bloat debt levels further, possibly sparking the wrath of ratings agencies. Further, we expect the Bank of Japan and other central banks to continue supporting the recovery, including through a weaker yen, also reinforcing investor views that Japan is light years away from tighter monetary policy.

Japan’s Ministry of Finance is unlikely to allow the US dollar/yen rate to fall below 1995’s ¥79.75 low for any length of time, for fear of unleashing another devastating round of deflation. A decline to those levels would lead to verbal and then overt intervention if warnings were not heeded.

Disclaimer: The National Australia Bank Limited accepts no responsibility for the information in this article.