Morgan Stanley see a bull market on the horizon

If you guessed USDJPY then give yourselves a pat on the back. If you didn't then you must be new to these pages ;-)

Yep, USDJPY is going to bull its way higher according to a special Japan report from Morgan Stanley over the weekend. The reasons?

  • Unsustainable JPY strength

  • Japan has become currency risk-averse

  • International availability of capital has improved

  • The Fed is coming back into play

  • High hedge ratios at odds with prospects of rising hedging costs

"Bottom Line: So far, the JPY has been the bullish surprise of the year. Multiple factors have driven this strength ranging from temporary factors such as fiscal year-end 'window dressing' (where financial institutions reduce net foreign bond exposures), to falling USD and EUR hedging costs that have allowed Japan's lifers to push hedge ratios to levels not seen since the financial crisis.

Japan has reduced its currency risk within an otherwise risk-friendly environment, which is unusual. We attribute this behaviour to US banks using new-found balance sheet strength to supply USDs into offshore markets, driving tighter cross-currency basis and cheaper hedging.

Cross currency basis swaps should remain tight, but with US rates rising, we expect hedging costs to rise from here. Over-hedged institutions may have to reduce their hedges (increase USD purchases) once the cost of hedging undermines the yield on Japan's foreign asset holdings. We believe USDJPY can head toward 118 in the near term."

In their weekly FX note, they're still working an order to buy USDJPY at 109.50 looking for 118.00, with a stop at 108.20.

They remain short AUDUSD at 0.7540 TP 0.6900, SL 0.7760. They are also hitting it off with a long in GBPNZD at 1.7690 TL 1.8700, SL 1.7465.

Here's their weekly summary.