Natural disasters’ impact on the Yen and broader markets

The week has gotten off to a bad start for Japan, though not because of Trump’s new tariff threats, since his attention is currently focused on the Middle East, but because of a 7.4 magnitude earthquake that struck the Pacific coast.

That said, earthquakes like this are not exactly uncommon in Japan, as the country lies in one of the world’s most seismically active zones at the intersection of four tectonic plates. And since the impact this time was fairly moderate with only limited damage, there wasn’t much of a reaction in the Japanese market.

But let’s imagine a disaster like the one in 2011 repeats. What happens then?

Fifteen years ago, beyond the tragic loss of life, the economic consequences included widespread infrastructure damage, major disruptions to supply chains, partial shutdowns of industrial production, and rising fiscal pressure on an already heavily indebted government. That in turn led to a credit rating downgrade.

From a market perspective, Japan’s Nikkei 225 dropped nearly 20 percent in the first two trading days, while CDS spreads widened by about 30 basis points on concerns about debt and reconstruction costs. At the same time, the yen initially strengthened to around 76.3 per dollar, as investors expected insurance companies to bring capital back to Japan to cover payouts. 

As for spillover effects, the global impact was relatively limited, although certain sectors, especially automotive and electronics, came under pressure due to supply chain disruptions and component shortages.

Of course, past market performance is no guarantee of future results, but it does show how investors tend to react in times of stress.

That said, even without natural disasters, Japan faces challenges. Specifically, if the Bank of Japan continues to raise interest rates and the yen strengthens, this could put pressure on the carry trade — and by extension, on USD/JPY positioning.

For years, Japanese financial institutions have borrowed cheaply in yen and invested those funds in higher-yielding foreign assets. However, if the yen appreciates, that strategy begins to unravel. Imagine earning returns in dollars while the dollar weakens against the yen: at some point, even a larger amount of dollars will not be enough to repay the original yen-denominated debt. This creates a snowball effect: investors rush to close out dollar positions and buy back yen, pushing the currency even higher and triggering further unwinding.

In that scenario, the pressure wouldn’t just hit Japanese equities; it could also spill over into U.S. markets.