JPY: Safe-haven appeal on display, carry unwind risks on the radar

Key points

• September panic: Markets entered a risk-off mode yesterday amid risks of a September sell-off and ahead of the US jobs report that roiled markets last month.

• JPY as a safe-haven: The Japanese yen was the outperformer in FX markets with its safe-haven appeal adding to the case for more rate hike from bank of Japan reaffirmed by Governor Ueda yesterday.

• NFP risk ahead: Markets are bracing for August jobs report due for release on September 6. Consensus is looking for higher headline jobs growth and lower unemployment print, but markets could be highly sensitive to any downside surprise.

• Carry unwind: In addition to its safe-haven appeal amid concerns over weakening global growth, yen gains could be further boosted if the potential unwinding of carry trades materializes, especially if a 50bps Fed rate cut for September becomes the base-case scenario.

The September curse has arrived, with markets entering a risk-off phase yesterday. Equities and cyclical commodities saw a sharp sell-off, while defensive sectors like consumer staples and yield-dependent real estate outperformed. The yen (JPY) stood out as a significant outperformer in the FX space, demonstrating its safe-haven appeal amid market turmoil.

Factors driving market movements

• September seasonality: Historically, September has been a challenging month for markets. Yesterday's first trading day of September for US markets set a negative tone.

• Economic data: Recent economic data has fueled market unease. The US manufacturing sector remains in contraction, and with key jobs data scheduled for release on September 6, concerns about US growth prospects are mounting.

Amid this volatility, the yen outperformed significantly, rising 1% against the USD and 2% against the AUD.

This rally is attributed to the yen's role as a safe haven. Additionally, Bank of Japan Governor Kazuo Ueda's recent comments bolstered the yen. Ueda reaffirmed the central bank's readiness to raise interest rates if economic conditions warrant, despite the accommodative stance due to persistently negative real interest rates.

NFP miss could amplify volatility

The upcoming Non-Farm Payrolls (NFP) report is crucial. A weaker-than-expected August report, following July's disappointing figures, could lead to a dovish repricing of US rate expectations. A 50bps cut might become a base case scenario for September, potentially undermining the dollar and worsening market sentiment. However, as we highlighted in our FX note yesterday, haven flows could still provide a floor to the US dollar.

Consensus expectations for August jobs stand at 165k from 114k last month and unemployment rate is expected to fall to 4.2% from 4.3% in July. This could make the weak July print look like a one-off, probably caused by the impact of Hurricane Beryl, and reaffirm soft-landing belief for the US economy. This would question the over 100bps of easing priced in for the rest of the year, and possibly result in some hawkish repricing. However, the ‘Fed put’ could still stay alive.

This suggests market could be more sensitive to a downside surprise in NFP despite the risks of over-dovish pricing of the Fed path.

Carry trade unwind risks

The market’s current volatility and the potential for a dovish shift in US monetary policy could reignite the risks associated with carry trade unwinds. Investors might close their positions in higher-yielding assets, increasing demand for safe-haven currencies like the yen as volatility jumps higher. While the yen's recent gains are driven largely by its safe-haven appeal, any resurgence in carry trade unwind risks could further boost its value. As a reminder, JPY rose by nearly 2% against USD and CAD on August 2, and 3.5% against the Mexican peso.

Performance of JPY against major currencies on August 2. Source: Bloomberg. Disclaimer: Past performance does not indicate future performance.

Meanwhile, positioning in JPY is mixed and close to neutral, indicating a lack of strong conviction in either direction, creating an environment where momentum plays can become a significant factor. The currency could be more sensitive to new information, leading to potential volatility as traders adjust their positions based on fresh insights. This makes the market ripe for sharp, potentially exaggerated moves, as the neutral positioning can quickly turn into a directional bet once a clear signal emerges.

Conclusion

The yen's rally amid yesterday's market sell-off underscores its effectiveness as a safe-haven currency. As we navigate through uncertain economic conditions and potential market shocks, the yen remains a key asset for investors seeking stability. In addition, the risks associated with carry trade unwinds and the upcoming economic data should be closely monitored, as they could significantly influence market dynamics and the yen's performance.

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