USD/JPY: Trading BoJ: When & At What Level To Sell? - Morgan Stanley

In a note to clients, Morgan Stanley provides some insights on its strategy to trade USD/JPY going into the BoJ policy meeting on Friday.

"Upside potential will remain corrective unless the BoJ – against previous communication – pushes its deposit rate into negative territory, which then would be the game changer for JPY. However, BoJ has been very critical on negative deposit rates elsewhere, arguing that the reflationary effect via a weaker exchange rate would be more than outweighed by negative deposits rates, leading to a sharp decline in monetary velocity including the hording of cash," MS argues.

"For a permanent weakening of JPY, the relative positions of yield curve would have to change. There are a number of technical factors preventing this from happening.

First, the BoJ curve is already super-flat. The long-end yield may only drop from here should the BoJ cut the deposit rate into negative territory, a move which it has refused so far and for which it has criticised the ECB.

Second, the JGB market has become increasingly illiquid due to the BoJ absorbing supply.More QQE via buying JGBs has relatively tight limits. Instead, the BoJ may consider buying more REITS or equity ETFs. These operations would be risk-positive, but would move the JGB yield curve into JPYsupportive territory," MS adds. 

"Accordingly, we define our trading strategy. The BoJ staying put suggests selling USDJPY at post-BoJ market rates.

Modifying its QQE programme by increasing the purchase of municipal bonds, REITs or ETFs would make us sell near 119.25, while an increase of its JGB purchasing programme by a monthly JPY20trn should allow for a bounce of USDJPY to 120.60 where we would sell again," MS advises. 

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