Yen's Safe-Haven Status Under Scrutiny

In a period of heightened global tensions, the Japanese Yen's safe-haven status is facing increasing scrutiny, potentially exacerbating selling pressure on the currency, which this week fell to an eight-month low. For decades, in times of market turmoil, from financial crises to geopolitical conflicts, investors have turned to the Yen as a safe haven. The logic is simple: Japan's massive current account surplus, stable political system, and deep-rooted domestic investor base make the Yen a reliable safe haven when risky assets plummet. But this conventional wisdom is now under pressure: On the one hand, the Yen's performance as a hedging tool is becoming increasingly unstable; on the other hand, the market's shift towards assets such as gold and avoidance of major currencies is also weakening the Yen's status. This week, after hard-line conservative Sanae Takaichi unexpectedly won the leadership election of Japan's ruling party, the USD/JPY exchange rate broke through the key 150 level. "Historically, we have often gone long on the Yen from a hedging perspective because in the last cycle, when there was a large amount of risk aversion in the market, the Yen performed quite reliably," said Keiko Kondo, Head of Multi-Asset Investment Asia at Schroder Investment Management. "But at the moment, we don't have enough reason to choose this type of hedging – the cost is higher, and the reliability is lower."

Changes in the Yen's Correlation with Financial Markets

The shift in the Yen's status is reflected in significant changes in correlation. Recently, the USD/JPY exchange rate has shown a frequent negative correlation with the S&P 500 index, coinciding with a period of domestic political turmoil in Japan. This means that the Yen strengthens when global risk appetite rises and weakens when market sell-offs occur – the opposite of what a safe haven should do. This "failure" stems in part from Japan's unique financial environment. Although major central banks around the world are shifting towards cutting interest rates, the Bank of Japan remains the only major central bank with a tightening bias. However, its policy normalization process is extremely slow, and Sanae Takaichi, who supports stimulus policies, tends to maintain a loose stance. "I no longer regard the Yen as a barometer of risk," said Ken Peng, Head of Asia Investment Strategy at Citigroup's wealth management division. "Today, the Yen is more reflective of market expectations – how much will the Bank of Japan raise interest rates, and can Japan's reflation and economic growth be sustained?"

Market Indicators

The 30-day correlation between the USD/JPY exchange rate and the Volatility Index (VIX) has turned positive, indicating that the currency no longer follows market volatility movements in the expected direction. Option markets are also sending similar signals: the implied volatility of the USD/JPY exchange rate has fallen sharply, indicating that the market generally lacks hedging urgency; while the risk reversal indicator (which measures the demand for upside and downside protection for an exchange rate) is continuously rising, meaning that market demand for betting on Yen weakness is increasing. Although Japan's benchmark 10-year government bond yield rose to nearly 1.7% this week, it is still far below the financing cost of US dollar assets of over 4%. This means that if investors go long on the Yen, they will face a significant negative interest rate differential loss. Although the Yen has appreciated nearly 3% against the US dollar this year, it is still among the worst performers in the G-10 currencies. The latest data from the US Commodity Futures Trading Commission (CFTC) shows that since the end of April, asset management companies have reduced their net long positions in the Yen by nearly 40%, while hedge funds are shorting the Yen.

Alternatives to the Yen as a Safe Haven

Traders are turning to other hedging tools. Strategists at Goldman Sachs and Bank of America believe that the Swiss Franc may be more reliable and less expensive than the Yen. This week, the CHF/JPY exchange rate has recorded a series of record highs, but this has not stopped bulls from entering; gold, silver, and Bitcoin are also gaining popularity. "There are many reasons for Japanese investors to increase their holdings of gold, including hedging against the risk of further Yen depreciation," said Takuji Tsukamoto, Senior Researcher at Pictet Asset Management Japan Ltd. Of course, the long-term appeal of the Yen as a defensive asset has not completely disappeared. "Although the so-called 'Sanae Takaichi trade' initially tends to weaken the Yen, it is expected that this trend will not last for more than a month, and the current stage is regarded as a temporary fluctuation," said Hirofumi Suzuki, Chief Foreign Exchange Strategist at Sumitomo Mitsui Banking Corp. He added that if the USD/JPY exchange rate rises to the 160 level, the possibility of the Japanese government intervening in the foreign exchange market will also increase.

Conclusion

But for now, lower global volatility has reduced the need for urgent hedging, and Yen-funded carry trades have regained their appeal. This means that the Yen is gradually moving away from its historical role and is more susceptible to speculative capital flows. "Japan used to give an impression of reliability due to 'policy stability and not being easy to change', but the political situation has now become uncertain," said Taketomo Shimizu, Chief Investment Officer of Fixed Income at Asset Management One Co. He concluded, "The Yen is not as trustworthy as it used to be."