The rebound of the yen may only be temporary, Morgan Stanley bets on arbitrage trades making a comeback, USD/JPY expected to rise to 163.
According to Jinse Finance APP, Morgan Stanley believes that the recent appreciation of the yen is mostly due to the closing of short-term arbitrage trades and market bets on Japanese capital repatriation, rather than any substantial improvement in fundamentals. As concerns over capital repatriation gradually dissipate and yen carry trades are rebuilt, the bank expects the yen to possibly fall back to its July lows and recommends going long on the US dollar against the yen, setting a target price of 163 yen per US dollar.
The Morgan Stanley strategist team, including Koichi Sugisaki, David Adams, and Andrew Watrous, has recently advised investors to go long on the US dollar against the yen, with a target of 163 and a stop-loss at 150. Around 163 is where the USD/JPY stood in late July, when a sharp depreciation of the yen prompted a rare joint intervention by Japan and the United States to buy yen and carry out coordinated action.
Currently, the yen is trading around 154 yen per US dollar and has recorded its first two consecutive weeks of gains in four months. The previous US-Japan joint intervention provided significant support for the yen, and this week the United States again sent signals of support. US Treasury Secretary Yellen sent a tough warning to traders betting on further yen depreciation, challenging the market's test of America's resolve to assist in bolstering the yen.
However, Morgan Stanley believes the recent rebound of the yen is not enough to change its generally weak medium-term fundamentals. The bank's strategists stated: "The recent strengthening of the yen appears to have been mainly driven by the unwinding of short-term carry positions, stemming from market speculation that Japan’s Government Pension Investment Fund (GPIF) might push for capital repatriation, rather than any change in fundamentals." They also emphasized that the likelihood of large-scale capital repatriation to Japan remains low.
For a long time, Japan's relatively low interest rate levels have made the yen a key global funding currency for carry trades. Investors can borrow yen at low cost and invest the capital in currencies and assets with higher interest rates to earn the interest differential. These trades continuously add selling pressure to the yen, which has been one of the key reasons for its long-term depreciation.
Recently, this trading logic was briefly disrupted. On the one hand, joint intervention by the US and Japan provided direct support to the yen; on the other, Bank of Japan officials have been sending hawkish signals, emphasizing continued increases in the benchmark interest rate and prompting investors to reassess the costs of carry trading funded by yen borrowing.
Meanwhile, the Japanese government has also been encouraging domestic pension funds to increase investments in the local market, fueling speculation that large Japanese institutions such as GPIF might sell overseas assets and repatriate capital. As investors worry about potential large-scale capital inflows back to Japan, some yen short sellers and carry traders have opted to close their positions, which has become an important factor behind the recent appreciation of the yen.
But Morgan Stanley believes that fears of large-scale Japanese capital repatriation may be overblown. If these expectations gradually fade away and the interest rate gap between the US and Japan remains significant, investors may rebuild yen-funded carry trades, once again putting depreciation pressure on the currency.
The strategists expect that as "excessive concerns about capital repatriation subside and carry positions are gradually rebuilt," the US dollar against the yen will return towards its fair value level. As a result, the bank recommends a long position in USD/JPY, targeting 163, which, calculated from the current level around 154, implies a potential depreciation space of about 5.5% for the yen against the US dollar.
