Yen Set for Gains in Volatile Markets

The JPY is poised for gains, and stands out as a stable choice amid market volatility. With expectations of steady strengthening against the USD and CHF, the JPY stands to benefit in both soft and hard landing scenarios, making it a key contender in the global currency market.

We believe August will prove to be a watershed month that brought growth to the fore as a driver of currency markets – it is now the key. Growth sets the context and determines the impact of lower global yields on currencies. If central banks are easing into a recession or an uncomfortably soft landing, the US dollar will likely resurges against most higher-beta currencies, underperform the yen – and maybe the franc – and remain roughly flat with some downside risk versus the euro. If we achieve a truly soft or no-landing growth scenario, the US dollar trends steadily lower against everything, with higher-beta currencies – Norwegian krone, Australian dollar, New Zealand dollar, and, to a lesser extent, British pound and Swedish Krona – leading the way higher. The euro, Canadian dollar, and Japanese yen will perform well versus the US dollar, but will likely underperform those higher-beta currencies. The Swiss franc may outperform the US dollar in either scenario but will likely lag behind most other currencies as it becomes a more attractive funding currency for carry trades.

Our base case is for an uncomfortable soft landing. We achieve a soft landing, but employment and consumption slow enough to create some recession anxiety and periods of short-lived US dollar strength. In that context, there will be US dollar rallies; however, with monetary policy rates normalizing, the bias should be to sell US dollar on rallies with a view to an eventual breakdown through the bottom of its two-year range. The yen is likely the best all-weather currency, as it wins in a soft landing—and wins big in a hard landing. Higher-beta, commodity-sensitive currencies are tough to buy right now, as they would be hard hit by additional volatility shocks – which we believe will become more common as we approach the US election – and adjust to the apparent new sensitivity of investors to pricing recession risk on any disappointing data.

US Dollar (USD)

We have long held the view that the US dollar is likely to fall at least 10–15% over the coming years as US yields and growth fall back toward the G10 average and the US grapples with high fiscal and current account deficits. For investors with a two-plus-year horizon, we have strongly recommended short US dollar positions to look through the highly uncertain transition period of the last 12–18 months. The transition from bull market to bear market is growing close, and we believe it is now time for tactical investors to be biased towards selling rallies rather than buying dips. In other words, we see the end of cyclical US exceptionalism clearly on the horizon—and approaching fast.

For those with a shorter horizon, we believe Recession – or even fear of recession – is likely to give the dollar temporary support, as will any anxiety regarding the upcoming US election. US rates are likely to remain relatively high compared to the G10 average, US equities continue to outperform, and the US retains its position as a relative safe haven due to its reserve currency status.

This makes it difficult to buy more cyclically sensitive currencies against the dollar at this point, as they are sensitive to recession risk, equity volatility, and the recent downtrend in commodity prices. It may be wiser to wait for larger selloffs to buy the Norwegian krone, Australian dollar, New Zealand dollar or Canadian dollar. While the yen is likely the best all-weather long against the US dollar and can be bought now with greater confidence.

Canadian Dollar (CAD)

The period of steady Canadian dollar-negative interest rate divergence appears to be over. However, we continue to hold a modestly negative tactical view on the Canadian dollar due to weakness in commodity prices, softer relative equity performance, and lower yields. On a more positive note, other central banks – particularly the Federal Reserve (Fed) – will also be easing policy. Because the Bank of Canada (BoC) cut earlier and at a faster pace than most other central banks, it is also likely to see the benefits of those cuts earlier. We can see this in improved growth expectations for 2025. Additional currency weakness is likely but also limited, as the markets have already priced in a fair amount of pessimism.

Euro (EUR)

We maintain a neutral to slightly negative tactical view on the euro, though we see it outperforming the more commodity-and risk-sensitive currencies – the Australian dollar, New Zealand dollar, Canadian dollar, and Norwegian krone – in this highly uncertain growth environment. The view is driven by weaker relative growth surprises, lagging European Union (EU) equity performance, and an increasingly negative signal from our short-term value model. That short-term value score indicates that the resilience in the euro is excessive relative to weaker growth and poor local equity market performance, despite a small improvement in relative yield differentials. The longer-term issues of high debt levels and low potential growth continue to cast a shadow—one that has become darker as French and German politics has become more fractured and less likely to lead to the required EU-wide reforms. On top of that, our long-run fair value model suggests that the euro is expensive versus most of the G10, except the US dollar and Swiss franc.

British Pound (GBP)

Our models maintain a neutral tactical view on the pound relative to the G10 average. The strength observed over the course of the year appears to fully price in the resilient growth data and high relative expected yields. As of month-end, the market is pricing the UK to have the highest policy rates in the G10 by mid-2025. Decent expected growth and relatively attractive yields suggest the pound should remain well supported. However, most of the good news is already priced in; absolute growth levels are lackluster, and the potential for limited fiscal support in the upcoming autumn budget all suggest there is limited room for additional appreciation.

Our long-run valuation model has a more positive outlook on the pound, as the currency screens as cheap relative to fair value. However, we expect that sticky inflation and chronically weak potential growth post-Brexit are likely to weigh on fair value, somewhat limiting the potential pound upside over the next several years.

Japanese Yen (JPY)

Going forward, we see further upside in the yen, with 140 versus the US dollar in sight by year-end and 130–135 by the end of 2025. This is consistent with another 25–50 bps increase in Japanese policy rates and 200 bps in cuts from the Fed. This scenario assumes a soft landing. If recession becomes a more serious risk, then we could easily trade well down into the 120s against the dollar, with even greater gains versus higher-beta, commodity-sensitive currencies. Altogether, this makes the yen one of the most attractive currencies in the G10, if not the most attractive, particularly against the US dollar and Swiss franc. Against US dollar and Swiss franc, the yen is likely to win in either a soft or hard landing, though a long position in the yen versus the franc has far less upside in a hard landing. On the flip side, in the event of a global reacceleration in growth and inflation – with monetary easing cycles cut short or even partly reversed – the yen may still win against the franc, though it would likely lose a fair amount versus the US dollar and most other G10 currencies.

Swiss Franc (CHF)

Our models maintain a positive tactical bias on the franc relative to the G10 average, thanks to resilient growth data and its relative safety in the face of a fragile global macro environment and falling commodity prices.

We caution that this positive bias is likely temporary, as our medium- to long-term view is decidedly negative. The franc remains the most expensive G10 currency per our estimates of long-run fair value, has the second-lowest yields in the G10, and core inflation – while unchanged in August – is the lowest in the G10. Meanwhile, the real-trade weighted franc is at the upper end of its 30-year range and the Swiss National Bank is cutting rates – we expect another cut in September- and is amenable to intervention to prevent excessive franc strength. We believe the franc is transitioning to a prolonged reversion back toward our estimate of its long-term fair value. Near-term strength should prove to be temporary support due to the increased political and market risk premium being priced into the more risk-sensitive currencies.

Norwegian Krone (NOK)

Our tactical krona signal shifted to neutral as an improving economic outlook offsets weak equity markets, lower yields, and signs that it is overbought after the August rally. Retail sales and services PMI have recovered somewhat; this suggests possible stabilization and nascent recovery. However, the economy remains near recession — with inflation effectively at target. We believe this will keep the Riksbank on the path toward three additional rate cuts this year, which should weigh on the krona. Risks for investors to price in a greater chance of a global recession — and heightened equity market volatility — should also tend to weigh on the currency. Thus, we stress that risks to our current neutral model signal are to the downside. We expect the krona to continue struggling over the coming months.

In the long term, the picture is more constructive: the currency is very cheap to long-run fair value and cyclically depressed — yet, at this point, we struggle to see a catalyst that could provide a sustained rally.

Australian Dollar (AUD)

Our tactical models remain negative on the Australian dollar due to the strong downtrend in commodity prices, soft local equity market performance, and the fragile global macro and geopolitical environment. The recent softening of Chinese economic data and the pickup in equity market volatility — which we believe will become more likely over coming months — are also important headwinds. On the bright side, there are positive factors that should limit Australian dollar losses. Most importantly, it is at historically cheap levels. RBA policy is likely to remain tighter for longer, with US rates expected to fall to or below Australian policy rates over the next six months. The economy is sluggish, but growth remains positive, as a decent fiscal spending backdrop should provide support to domestic demand. Thus, while we are negative on the currency, we do not expect substantial downside.

In the long term, the Australian dollar outlook is mixed. It is cheap relative to the US dollar, British pound, euro, and Swiss franc — and has room to appreciate — but it is expensive against the yen and Scandinavian currencies.

New Zealand Dollar (NZD)

Our tactical model remains negative on the dollar. The benefit of New Zealand’s high yields is fully offset by ongoing challenges to growth and the weak external balance — the current account is –6.8% of GDP — and weaker commodity prices. Now that the RBNZ has cut rates and taken a dovish outlook, the yield support should also wane. In addition, recent softness in Chinese growth, higher equity market volatility, and rising geopolitical risk are all persistent headwinds for the dollar. We agree with the market’s apparent reaction that rate cuts are necessary and good, but the benefits will take time to materialize. The New Zealand dollar outlook remains challenging in the near term.

In the long term, our outlook for New Zealand dollar is mixed. Our estimates of long-run fair value suggest that it is cheap versus the US dollar and Swiss franc, with ample room to appreciate, but it is expensive against the yen and the Scandinavian currencies.