Morgan Stanley: Yen Rally Won't Break Emerging Market Carry Trades

Morgan Stanley's team, led by James Lord, believes emerging market (EM) carry trades can withstand the recent yen rally without an additional catalyst to raise broader volatility. The yen jumped to 152.89 per dollar on Tuesday, its strongest point since mid-February, as markets increased bets on the Bank of Japan raising interest rates and remained vigilant for potential official support. However, Morgan Stanley's team sees bigger drivers than the yen's latest move: global currency volatility, the health of the global economy and stock markets, and whether individual emerging markets still offer strong fundamental stories.

According to Morgan Stanley, 'Global growth, global stock market performance and the bottom-up trends of key EMs are more important for the performance of EM carry trades than movements in JPY.' They add that they remain constructive on their view and continue to recommend buying EM on dips with bottom-up fundamentals, decent carry, and resilient global growth helping to keep investors engaged in the asset class.

Early read-throughs suggest resilience. Since July 29, Brazil's real is down 5.1% against the yen and Colombia's peso is lower by 3.4%, yet both gained versus the dollar by 0.7% and 2.4%, respectively. While the yen has long been a favored funding currency, investors have been spreading that role to the euro and the Swiss franc as they finance higher-yielding bets.