Safe-haven demand fuels Japanese Yen surge as risk appetite fades

• Safe-haven flows into the Japanese Yen push USD/JPY lower as risk appetite weakens.
• Lower US Treasury yields reduce the yield differential with Japan, giving the Yen additional support.
• Next week's Fed and BoJ policy decisions are in focus, with traders expecting both central banks to raise rates further.

USD/JPY is down nearly 0.65% on Thursday. The pair is heading for its largest one-day fall in a month as mounting worries about AI-related investments pressure global equities and weaken risk appetite. Renewed demand for safety is lifting the Japanese Yen (JPY) against its peers. Trading around 157 at the time of writing, USD/JPY is at its lowest since 30 September.

A modest US Dollar (USD) rebound has not prevented the Yen from recovering. Traders appear to prefer the Yen to the Greenback as the US sits at the centre of the AI investment boom. After touching a three-week low of 101.45, the US Dollar Index (DXY) is trading around 101.75. The index measures the Greenback against a basket of six major currencies.

Government bonds are also attracting safe-haven flows, lowering yields across major economies. This is reducing the US-Japan yield differential and adding support for the Yen. At around 5.04%, the benchmark 10-year US Treasury yield is down 1% on the day. Japan's 10-year government bond yield is near 2.86%, a daily decline of 0.50%.

Further Yen gains could nevertheless be constrained by the still-wide US-Japan yield differential and persistent concerns about Japan's heavy debt burden. The Bank of Japan's (BoJ) gradual policy tightening may also have little impact on the interest rate gap with other major economies. Central banks remain hawkish as the Middle East conflict poses energy-related inflation risks.

For the late-October meeting, Standard Chartered analysts forecast no change in Bank of Japan policy: “We expect the Bank of Japan (BoJ) to keep the policy rate unchanged at 1.25% at its 29-30 October meeting, following September’s 25bps hike.” They nevertheless expect officials to “maintain a clearly hawkish tone,” adding that “the debate is increasingly shifting from whether the BoJ will hike again to when the next hike will occur.” December is now seen by the analysts as “a live meeting,”

but Standard Chartered stresses that “January 2027 remains our base case for the next hike.” The bank also sees reasons for the BoJ to proceed with gradual normalisation: “the BoJ has an incentive to continue policy normalisation to support yield differentials and reduce the risk of renewed JPY weakness, particularly if the Fed resumes tightening or maintains a restrictive policy stance for longer than expected.”

Following September's 25 basis points (bps) increase, the Federal Reserve (Fed) is likewise widely expected to hold US interest rates steady next week. Policymakers remain focused on returning inflation to the 2% target, however. Traders have therefore almost fully priced in a further December rate rise, with the CME FedWatch Tool indicating a probability of around 89%.