JPY: The Trend Has Turned: 5 Reasons For Our Bullish Call - Morgan Stanley

Our 2016 FX outlook published in November called for this year to be the year of 'USD and JPY strength'. While we were correct in the direction of our view, the magnitude and pace of JPY appreciation have surpassed even our out-of-consensus bullish expectations, with USD/JPY already trading near our initial year-end target.

As such, we have revised our forecasts, now expecting USD/JPY to trough at 105 later this year before staging a mild rebound.There are five pillars for our JPY bullish call.

First, the Japanese have the largest net international investment position in the world. Over the past few years alongside Abenomics, Japanese investors' FX hedge ratios on foreign securities have been materially lowered. Given our more cautious asset outlook, we think that the risks are skewed toward these hedge ratios increasing.

Second, an aging population means that foreign assets will need to be monetized and brought back home to support those moving into retirement, adding to repatriation pressure. 

Third, we are not forecasting the BoJ to implement any policies that we would deem sufficient to turn around the JPY strengthening trend. We believe that further QQE or deeper cuts into negative territory will have limited pass-through to a weaker currency.

Fourth, we are forecasting foreign yields to continue moving lower. We expect only one hike from the Fed this year, but more easing from the ECB and for nearly half of Asia to continue cutting rates. Interest rate differentials between Japan and the rest of the world are likely to shrink, limiting outflows from Japan.

And fifth, JPY remains undervalued on a longer-term horizon. The JPY REER is still near the bottom end of its long-term range,and well below the long-term average even with the most recent bout of appreciation.

Consequently, we believe that JPY will be the strongest currency globally this year and is the only currency in the majors that we forecast strengthening against USD in 2016.

MS targets USD/JPY at 114, 110, 105, and 106 by the end of Q1, Q2, Q3, and Q4 respectively.

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