Yen Bulls Are Back: Morgan Stanley Ranks It Cheapest of All

Updated on
  • Positioning, options point to first annual gain in four years
  • Rally may end slide that reached 31% since Abe took office

An unlikely event is developing as the Federal Reserve moves closer to its first interest-rate increase in almost a decade: Yen bulls have re-emerged. 

Japan’s currency is on course to avoid a record fourth-straight annual loss as a stuttering global economy revives haven demand and weakens the case for the Fed to raise rates more than once in 2015.

The odds the yen will complete a yearly gain have more than doubled over the past month to 55 percent, data compiled by Bloomberg based on options show. Meanwhile, risk reversals show yen bulls are the most dominant in 19 months, bears are cutting bets on declines and Morgan Stanley says the currency is “deeply undervalued” against peers considering inflation and trade patterns.

“The risk of the yen ending the year stronger is growing,” said Daisuke Karakama, chief market economist at Mizuho Bank Ltd. in Tokyo. “The main scenario is for the Fed to raise rates once this year and stop normalizing next year as it feels the pain of the strong dollar, but the probability has risen over the past two months that the Fed may have to forgo a hike this year.”

The yen has surged 3.9 percent since the day before China unexpectedly devalued the yuan on Aug. 11, the most among some 150 currencies tracked worldwide by Bloomberg after Madagascar’s ariary. The currency was at 120 per dollar as of 7:48 a.m. Tuesday in New York.

Cumulative Loss

Japan’s currency was 4.9 percent down for the year on June 5, when it reached 125.86 per dollar, the weakest level in 13 years. It started sliding at the end of 2012, when Shinzo Abe became Prime Minister with a pledge to expand monetary stimulus to revive the economy. There was an 11 percent loss in 2012, an 18 percent tumble the following year and a further 12 percent drop in 2014. The cumulative decline reached 31 percent at the nadir in June.

The yen is now the most attractive of all the currencies covered by Morgan Stanley, when comparing the real effective exchange rate with its long-term average, New York-based foreign-exchange strategists Evan Brown and Calvin Tse wrote in a Sept. 3 report.

“The yen is the most undervalued on our metrics, not just across the Group of 10 but all currencies we cover,” they wrote.

Betting the yen will strengthen against other Asian currencies such as the Chinese yuan and South Korean won is one Morgan Stanley’s most-favored long-term ideas, the analysts said.

Market metrics show investors are becoming more bullish. The premium for options to buy the yen in three months versus those to sell it widened to 1.40 percentage points on Tuesday, the most on a closing-market basis since February 2014, risk-reversals show.

At the same time, hedge funds and other large speculators have reduced bets on a weaker yen. Net positions that profit from declines in the currency fell to 15,555 contracts in the week ended Sept. 1, from 105,226 three weeks earlier, data from the Washington-based Commodity Futures Trading Commission showed.

Bank of Japan figures indicate yen lending by Tokyo’s foreign bank branches to their offices abroad, a gauge of demand for the currency to fund overseas investments including carry trades, dropped in July after recovering to about half of the 23 trillion yen level set at the peak in 2007.

If those positions were to slide back to where they were before they started rising in 2010, the yen may appreciate to 105 per dollar, according to Tohru Sasaki, head of Japan markets research at JPMorgan Chase & Co. in Tokyo.

A review of past trading levels shows that in 12 of the past 25 years the yen reached its strongest level for the year in the fourth quarter, and it often starts to appreciate in August, said Sasaki, who worked at the Bank of Japan until 2003.

“There’s a possibility that the dollar will fall from here,” he said. “The yen has never weakened four years in a row, and while I’ve been thinking the yen could end this year marginally lower, I’m not so sure now.”

Narrowest Range

Sasaki also said the yen may be poised to break out of this year’s 8.6 percent trading range, which is tighter so far than the 10 percent seen in 2006 that was the narrowest in the past quarter century. If it does, the 2015 high of 115.86 in January is much closer than the June trough of 125.86.

“For the pair to end the year without exceeding the current high or low of the year would be a very bold prediction, to say it will end in a narrow range not seen in 25 years,” he said.

For Mizuho’s Karakama, any waning in the likelihood of Fed rate increases may mean any weakening trend for the yen comes to an end between October and December of this year, rather than in the first quarter of 2016. Futures traders see a 28 percent chance of a September rate rise in the U.S., down from 54 percent odds seen Aug. 7.

“You couldn’t go wrong saying the dollar would rise on the Fed’s normalization the past two years, but that scenario faces scrutiny in the coming four months,” he said. “One more stock plunge and the Fed strikes out on a rate hike.”