Here Is Why The JPY Has Further Upside? - Morgan Stanley

Here Is Why The JPY Has Further Upside? - Morgan Stanley

12 April 2016, 14:17
Vasilii Apostolidi
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We expect further flows from various market participants to continue to support JPY.

First, Friday’s reluctance for JPY to weaken (indicating de-risking ahead of the weekend) suggests that ‘the Street’ has not traded JPY long in significant amounts last week. Note that CFTC data showed the most net long positions building in the first four weeks of the year. Instead our client conversations focusing on the BoJ and its ability to weaken JPY are suggesting to us that the market has not fully adopted our view, suggesting JPY strength staying with us for even longer.

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Second, Japan’s retail accounts may still need to wind down their JPY-funded carry trades, suggesting more of this ‘P&L’ driven JPY buying in store.

Third, pension funds and financial institutions' foreign assets relative to total assets are near historical highs and most importantly still hugely currency-unhedged. The GPIF had allocated 36% of its portfolio to foreign assets at the end of December 2015.

The BoJ's ability to weaken JPY remains limited, as we highlighted on Friday. Sovereign bond purchase-focused QE can no longer rely on the JGB yield curve acting as a transmission mechanism. Negative interest rates seem to undermine banks and monetary velocity, hence strengthening and not weakening JPY. The BoJ’s tool box appears to be limited to the purchase of private assets such as ETFs. The JPY-weakening impact of such BoJ equity purchases should be limited. The mechanism of JPY weakness in this scenario would be limited to the de-FX-hedging of equity portfolios, where many global equity investors have used JPY as a ‘quasi’ hedge for equity risk.

The second-round effects of JPY strength would terminate the USD downward correction, especially against liquid high-yielding currencies with the EM spectrum. Within the DM world it might be AUD suffering most. China's CPI remaining steady at 2.3%Y puts focus on this week's trade and GDP data.

We put special focus on AUDJPY, which offers significant downside potential from here should JPY-based investors pile out of carry trades. Another interesting factor driving AUDJPY down comes via the Fed and risk appetite. 

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