Goldman Sachs says the Japanese yen is the 'ideal hedge' against a US recession given its weakness against the dollar

• The Japanese yen shows "significant value" as a hedge against a US recession, Goldman Sachs said.
• Goldman Sachs said part of its bullishness towards the yen is how cheap it is compared with other typical safe-havens.

Goldman Sachs believes the Japanese yen is an ideal hedge against the risk of a US recession, which the investment bank believes is a possiblity in the coming two years.

In a research note published on Tuesday, Goldman analysts, led by Karen Reichgott Fishman, noted that the yen is trading at "extremely cheap levels" and is undervalued aga ins the dollar to the tune of 20-25%.

"In other words, the yen is now trading at historically cheap levels and screens as the cheapest safe haven asset by far—at a time when global recession risk is on the rise," Fishman wrote.

Fishman said the yen looked especially cheap compared with other traditional safe haven currencies such as the US dollar or the Swiss franc.

The yen has been diving against the dollar and reached a 20-year low last week, partly because of the widening gap between US and Japanese interest rates, as the Bank of Japan has left monetary policy unchanged, while the Federal Reserve is in an aggressive tightening cycle to combat inflation running at 40-year highs.

The BoJ meanwhile has pledged to cap the country's 10-year government bond yield at 0.25%, while 10-year Treasuries are yielding more than 3% right now, the biggest difference between the two since late 2018.

Fishman said the situation has "opened up significant value" for the yen as a hedge against what the bank estimates is a 35% chance of a US recession within the next 24 months. "Our latest work on FX hedges for key risk scenarios shows that the yen screens as the most effective hedge against a 'risk down, US rates down' shock—or a market backdrop consistent with recessionary pricing."

A rising dollar-yen however, is likely to call for intervention, Fishman noted, especially at a time when commodity prices, like energy, skyrocket as a result of foreign sanctions from Russia's war with Ukraine. "Over the short-term, amidst highly volatile global markets, the yen will likely be influenced by changes in Treasury yields and commodity prices," she said.

Given Japan's reliance on energy imports in particular, which are priced in dollars, the extreme weakness in the yen means there is a greater chance the central bank will step in to support the currency and avoid an even bigger increase in inflation.

"The combination of cheap valuation, non-trivial risk of intervention, and, most importantly, rising odds of recession to open up paths to dollar-yen downside," she said, referring to the potential for the yen to strengthen against the dollar.

"cheap valuation, non-trivial risk of intervention, and, most importantly, rising odds of recession" will lead to a dollar-yen downside, meaning a greater opportunity to sell the dollar and buy the yen.

"Cheap valuation and rising odds of recession argue for a more constructive view on the Yen over the next year," Fishman said.