Yen turns into better hedge against AI-driven market shock, thanks to Japan’s policy backdrop changes: Goldman Sachs

Goldman Sachs says the yen is becoming a more effective hedge. It can protect against a market shock driven by artificial intelligence.

The reason is a change in Japan’s policy backdrop. According to Goldman Sachs, this change reduces the risk of a sharp fall in the yen’s value.

This risk arises when global yields rise. With the policy backdrop changing, the yen is now less likely to weaken sharply in such a situation.

“The yen now looks like a more attractive hedge for procyclical portfolios than it has been over recent years, despite the global backdrop still arguing for further JPY weakness,” Bloomberg quoted strategists including Kamakshya Trivedi as writing in a note dated 23 October.

The call comes after the yen showed signs of its old haven nature. This happened during last week's global rout in tech stocks.

On Thursday, the yen surged 0.9% against the dollar. On Friday, it briefly reached its strongest level in more than a month. Concerns over the AI investment boom pushed equities lower. They also sparked a sharp rally in Treasuries.

Later, the yen gave up some of those gains. This happened as US yields stabilised.

Goldman argues that the AI boom has left US equities and the dollar exposed. Both are particularly open to a worsening growth outlook.

Suppose a shock pushes stocks and bond yields lower at the same time. According to Goldman, this kind of market setting has historically been most favourable for the yen.

Goldman also sees early signs that the yen is becoming less vulnerable. This is true when global yields move higher. Recently, the yen has weakened less in response to rising yields. The weakness has been more limited than in the past six to seven years.

According to the strategists, this likely reflects reduced pressure on the currency. The pressure comes from Japan's domestic policy settings. These settings now push the yen down less than before.

That is a contrast with 2022. Back then, the Bank of Japan kept yield-curve control. This happened as global borrowing costs surged.

This changing link means something for the yen. Goldman said it "should be a less painful hedge to hold". This is so even if carry remains negative.

Other factors are also helping. Japan's domestic policy backdrop is now more constructive. The yen's valuation is cheap. The risk of currency intervention is also high. Together, these limit the possible upside in dollar-yen. This improves the balance of holding the yen as a hedge.

Near future vs longer period

In the near term, Goldman still favours selling the euro against the yen. There is little obvious domestic reason for a big rise in the yen. It also says the bar is high for the BOJ to surprise markets. A hawkish message at its 30 October policy decision is unlikely, Bloomberg reported.

Over a longer period, the picture looks different. Goldman's strategists see the dollar-yen trade as the better protection. It can guard against a fall in risk sentiment.

The strategists wrote that a short position in USD/JPY should be the most effective hedge. They said it can protect against general wobbles in growth. It can also protect against a broad AI shock.