Morgan Stanley on what's next for the euro and yen
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Brexit could help push EUR/USD lower
Watching EUR: A sustained EUR decline requires either long-term capital exports via EMU-based financial institutions to exceed the region's ~2% of GDP current account surplus or EUR to be used extensively as a funding currency.
Insurance companies have been held back from investing abroad by high FX volatility reducing risk-adjusted returns,and higher-leveraged core EMU banks have been repatriating funds instead of providing non-EUR-based entities access to their EUR-denominated balance sheets. Using EUR for funding purposes has to be run via the EUR-denominated corporate bond market, which at this point is not sizeable enough to create sufficiently high EUR funding-related outflows for EUR to weaken
EURUSD will have to break below 1.1220 (close to the April low) to break ranges to the downside.With the flow picture staying EUR-supportive it may require seeing EUR used as a proxy for hedging Brexit risks to push it lower at this stage. EUR-implied volatility trades at a fraction of GBP volatility. Hence, selling EUR via the options market seems lucrative to us.
Look for USD/JPY declines
JPY's real yield support: JPY should emerge as the outright winner at this point, benefiting from rising real rates. This morning's release of April PPI falling from -3.8%Y to -4.2%Y indicates that the inflation outlook has shifted radically, pushing real yields even higher.
Falling risk appetite should support surplus and saving currencies relative to deficit and investment currencies, which nowadays often represent economic are as deploying massive overcapacities. JPY benefits from Japan's 75% GDP net foreign asset position and the BoJ struggling to bring JPY-supportive real rates down. Instead of moving towards a quick implementation of 'helicopter money', the BoJ continues to discuss already tested and recently failing policy themes such as QQE, private asset purchases and a further cut in already negative interest rates.
Ahead of the G7 Finance Ministers meeting on May 20-21 in Sendai followed by the G7 head of states meeting on May 26-27 in Ise-Shima, FX interventions are unlikely, supporting our view to sell USDJPY into strength.
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