Japanese Yen surges as risk-off mood drives safe-haven demand

• USD/JPY falls as risk aversion drives safe-haven demand for the Japanese Yen.
• Falling US Treasury yields narrow the US-Japan yield gap, providing further support to the Yen.
• Traders await next week's Fed and BoJ decisions, with further rate hikes expected from both central banks.

USD/JPY loses nearly 0.65% on Thursday, on track for its biggest daily decline in a month, as growing concerns over AI-related investments weigh on global equities and dampen risk sentiment, driving renewed safe-haven demand for the Japanese Yen (JPY), which is outperforming across the board. At the time of writing, the pair trades around 157, its lowest level since September 30.

The Yen's recovery comes despite a modest rebound in the US Dollar (USD). With the US at the centre of the AI investment boom, traders appear to favour the Yen over the Greenback. The US Dollar Index (DXY), which tracks the Greenback's value against a basket of six major currencies, trades around 101.75 after hitting a three-week low of 101.45.

At the same time, the risk-off mood is driving demand for government bonds, pushing yields lower across major economies. The narrowing US-Japan yield gap provides further support to the Yen. The benchmark 10-year US Treasury yield stands around 5.04%, down 1% on the day, while Japan's 10-year government bond yield trades near 2.86%, down 0.50% on a daily basis.

However, the Yen's upside could remain limited as the US-Japan yield gap is still wide, while concerns over Japan's heavy debt burden continue to weigh on the currency. Meanwhile, the Bank of Japan's (BoJ) gradual tightening may do little to narrow the interest rate gap with other major economies, as central banks remain hawkish amid energy-driven inflation risks from the Middle East conflict.

Analysts at Standard Chartered expect the Bank of Japan to stay put at its late-October meeting, saying, “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.” However, they anticipate that officials will “maintain a clearly hawkish tone,” noting that “the debate is increasingly shifting from whether the BoJ will hike again to when the next hike will occur.” While they now regard December as “a live meeting,”

Standard Chartered emphasises that “January 2027 remains our base case for the next hike.” The bank also argues that the BoJ has an incentive to press ahead with gradual normalisation, as “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.”

In the US, the Federal Reserve (Fed) is also widely expected to leave interest rates unchanged next week after raising them by 25 basis points (bps) in September. However, given policymakers' continued focus on bringing inflation back to the 2% target, traders are almost fully pricing in another rate hike in December, with the CME FedWatch Tool placing the odds at around 89%.