Country Damaged By Tsunami-Currency Gets Stronger

The somewhat strange logic of currency markets was illustrated today as they reacted to the news of Japan suffering large damages caused by a tsunami by bidding up the value of its currency, the yen, by more than 1%.

There is of course an explanation for this, namely that because currency movements are to a great extent determined by interest rate differentials and because Japan is closer to the zero bound barrier than others and because this will weaken global economic activity, this will reduce the yield advantage of other countries and so make Japanese bonds more attractive given a certain exchange rate. The increased demand for Japanese securities this creates causes in turn an appreciation of the yen.

Howervr, while this can be explained, it illustrates why floating exchange rates do not always reflect "economic fundamentals" as advocates of that system often asserts.