Morgan Stanley's Jen: The 'Schizophrenic' Yen

Stephen Jen, Chief Currency Economist at Morgan Stanley (London), provided a forecast update of global currencies in the June 15th edition of the Global Economic Forum, in which he said the JPY-story remains "schizophrenic."

Overall, he expects more yen weakness, but sees the possibility of an outperforming Nikkei supporting the yen by autumn.

Jen acknowledges his earlier realization of the importance of 'portfolio shift' among Japanese investors -- essentially a sizable portion of the yen carry trade as Japanese investors seek higher yields overseas -- and how it is keeping downward pressure on the yen.

The Japanese economy is "doing just fine," says Jen, based on Q1 GDP growth of 3.3%, ranking it second among G10 economies behind Canada.

He notes if there is a re-accelerating of the global economy, Japan could be the next major country to be re-rated by investors.

As many investors are aware, the Nikkei has underperformed global markets and suffered the most after the risk-reduction in Feb. and March. Jen says since there's no threat of outright inflation (or an inflation scare), Japan will stay in a "Goldilocks" state longer than other countries.

This all sets up the Nikkei for a late second-half rally, especially if local investors repatriate funds to take part in the action as the Nikkei outperforms.

However, Jen says if the Nikkei continues to lag, then he "would not recommend that investors put on long-JPY positions." (emphasis added)

Over the near term, Jen explains it's best not to challenge the weak yen trend. Breaking 122 was significant given past failures to do so since '05. Likewise, in a global tightening environment, the JPY could get "left behind" and therefore, "could linger in the low-120s in the coming months."

See the chart below of the CurrencyShares Japanese Yen Trust (FXY) as of Monday 6/18 intra-day A.M.

Those who follow my weekly coverage of Japanese ADRs/ETFs and other posts on Japan, will notice a lot of my views are in-line with those of Mr. Jen.

What is difficult to assess however, is how much support domestic investors will provide in the event of an outperforming N225. Also, how much of carry trade allotted funds will be repatriated and channeled into domestic stocks, versus allotting of available funds from savings, bonuses and disposable income.

The Nikkei remains on an upward trend and is set to top its late February multi-year high. However, at this point, ahead of the upper house election next month (7/22) and the uncertainty surrounding Japanese politics, foreign investors may be in a race with domestic investors to take profits.

Assuming a positive political climate later this summer, it begs the question if foreign investors will lead a second-half rally.

See below for a chart of the Nikkei 225 Stock Average (Friday 6/15 close) and iShares MSCI Japan Index ETF (EWJ) as of Monday 6/18 intra-day A.M.:

     

Further reading: What Will Unwind the Carry Trade? • Expect Higher U.S. Rates To Attract Japanese Investors • Currency Trading: Profit From The World's Biggest Casino • Weak Yen Likely to Weaken Further Ahead of Bonus Payouts

Disclosure: The author does not own shares of any companies/funds mentioned in this article.