No reason for USD to correct, no look-back for USD/JPY says Morgan Stanley

"USD strength is making the headlines, with the DXY Index trying to make its way through the key 100 level, but we are noticing that the weakness in JPY is being debated less.

We think the rising USDJPY is the real pain trade in respect of positioning. That said, the moves in the JGB market are being closely watched by our team. On JPY positioning, when the USDJPY rally started in September the JPY long position was extreme relative to its long-term average. Now, as the pair trades impulsively higher, supported by rapidly gaining real yield differentials, investors are not as long as they would like to be, given the change in the global macro picture.

Hence, we think it may be wrong to speculate that the DXY is forming a 'triple' top coming off from here. Markets will be looking for a break of the 100.51 high in the DXY from December 2015. We see no reason for USD to correct and USDJPY to trade lower.

Stronger US data: As US bond market volatility eased yesterday, USDJPY in particular was able to move higher based on an upside surprise in US economic data. In fact October saw the best rise in core retail sales since April, with support from a slightly better Empire State Manufacturing PMI for November (+1.5 after -6.8), driven by the new orders and shipments. The President-elect's fiscal and deregulation proposals have fallen on very fertile ground, namely a US economy showing signs of closing it eight-year output gap. For markets the inflation data are important as the sharp rise in US nominal yields is this time not being primarily driven by rising real rates as seen during the 2013 taper tantrum, but by upward-adjusting long-term inflation expectations.

Accordingly, there may be no look-back for USDJPY: JPY remains vulnerable at this stage as global reflation signals become stronger by the day. Even in Japan 3Q growth has been stronger than expected, providing a positive signal of Japan's own inflation expectations. Lower Japanese real yields are undermining JPY".

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