If the emerging COVID-19 variant Omicron has pulled a fog of uncertainty over financial markets, it is also shining a bright light on the unique allure of the Japanese yen. The yen's 1.8% surge on Friday was its biggest since the pandemic struck, one of the largest in years, and echoed previous bouts of global volatility in which the yen was the world's safe-haven currency of choice. When markets seize up and investors duck for cover, yen-funded "carry" trades are often closed or reversed, some of the huge pool of Japanese capital deployed around the world is repatriated, and the yen shoots higher. With government bonds already expensive, investors have fewer assets to hedge exposure to riskier bets like stocks, should fears persist over what the new COVID variant could do to the global economy. The cheap and highly liquid yen is one. MUFG's global head of research, Derek Halpenny, notes that there have been eight "risk off" periods since the COVID outbreak in March 2020, characterized by the S&P 500 falling 3% or more. The first four last year were more severe, and the yen was the best-performing G10 currency in each of them. The four episodes this year were less severe, and the yen did not perform as well. Then came the stock and commodity selloff on Friday, a reminder that in bursts of sudden volatility, investors turn to Japan's low beta, low-yielding, and large current account surplus currency more than almost any other asset. "Extrapolating risk-off events in 2021 has been pretty difficult. We haven't had very many. (But) If there's follow-through from this ... there's more to play out," Halpenny said. CLOSE CORRELATION Foreign exchange market giants Deutsche, JP Morgan and Goldman Sachs are among those arguing that an increasingly hawkish outlook for U.S. interest rates and widening yield advantage should lift the dollar against the zero-yielding yen. Only last week, as rates markets prepared for Fed lift-off in June and at least 50 basis points of tightening next year, JP Morgan raised its mid-2022 dollar/yen forecast to 117.00. This is the thinking that propelled the dollar to a near five-year high above 115 yen this month. The yen is down 9% against the greenback this year, well on track for its biggest annual fall since 2014. Anticipating further weakness, investors are heavily short the currency too, by some metrics holding their largest short yen position since 2015. But that is upended in a world of lockdowns, travel bans, shuttered businesses, and closed borders, all potential scenarios amid the uncertainty created by the new variant as drugmakers scramble to upgrade vaccine efficacy. If the fed funds outlook is dialed down and Treasury yields do not rise as expected - if at all - then a good chunk of dollar/yen's support is removed. Sovereign divergence becomes sovereign convergence. Dollar/yen is the G10 currency pair most closely correlated to U.S. yields. According to one measure highlighted by Goldman Sachs, the correlation is 80%, almost double the next=most correlated currency, the Swiss franc. 2022, YEN HEDGE YEAR The symbiotic relationship between U.S.-Japanese yield spreads and dollar/yen, particularly in times of heightened market volatility, is well-established. The crises of 1998 and 2008, which triggered some of the yen's strongest gains on record, have passed into FX market folklore. Of course, foreign exchange market volatility, equity market disruption, and yield spread compression today are nowhere near those extremes. But they are high enough to warrant close attention. Those two good old-fashioned currency market drivers, positioning and momentum, could also act as a tailwind for the yen, a currency that enjoys the structural support of a current account surplus every year going back almost four decades. The latest data shows that half of the $22 billion net long dollar position held by speculators and funds on U.S. futures markets is against the yen. Put another way, they are significantly more bearish on the yen than any other currency. This indicates scope for short covering, which would accelerate any yen upside. As Deutsche analysts point out, the yen's "persistently cheap valuation on just about any metric" should make investors think twice before attempting to push it lower. "Throughout much of the pandemic the dollar was deemed the go-to 'risk aversion' currency in FX. Not anymore. For 2022, we look for the yen to take over as the most effective barometer to hedge risk," predicts Neil Jones at Mizuho in London. By Jamie McGeever in Orlando, Fla. Editing by Matthew Lewis Our Standards: The Thomson Reuters Trust Principles.