Morgan Stanley Wants You To Buy The USD/JPY FX Dip

Analyst Hans Redeker comments "The USDJPY cross currency basis has significantly narrowed over recent weeks, with the 3-month basis swap coming down to 22bp yesterday from 91bp in November. USD hedging costs out of JPY can be put into two components, namely the USD T-bill rate and the cross currency basis. When the USDJPY cross currency basis widened over recent years, it acted like a ‘tax’ on hedging activities for Japanese investors, thus holding back hedging activities. Now as the cross currency basis has come in, it has unleashed hedging activity, putting USDJPY under selling pressure, but we like to buy the USDJPY dip at 109.50."

Further, Japan is driving the FX pair higher. To wit: "With Japan lifers' hedging ratios reaching the upper end of the ranges experienced within the current decade, we wonder what would happen once the US T-bill rate starts breaking higher. FX hedges are rarely done on contracts going beyond a year; more common are 3-6 month swaps. These swaps have become cheaper with the cross currency basis tightening, but with the USDJPY basis swap now at 22bp, the hedging cost relief coming from a further tightening of the basis is limited. Against this stands the likely increase of Fed funds rates driving the T-bill rates up."

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