Morgan Stanley expects yen to decline as traders rebuild carry trades

Morgan Stanley is betting against the yen, projecting the Japanese currency will slide to roughly 163 per US dollar by late July 2026. The call is built on a straightforward thesis: the yen’s recent rally was a head fake, driven by carry trade unwinding and speculation about pension fund repatriation, not any real shift in the economic backdrop.

With USD/JPY currently hovering around 154, that forecast implies a roughly 6% decline in the yen from here. Morgan Stanley’s strategists, including Koichi Sugisaki, David Adams, and Andrew Watrous, are recommending clients go long on the dollar-yen pair with a stop-loss set at 150.

Why the yen rallied, and why Morgan Stanley thinks it won’t last

The yen’s recent strength caught some traders off guard. But Morgan Stanley’s team argues it was largely a mechanical event rather than a fundamental one.

Specifically, the rally traced back to speculation that Japan’s Government Pension Investment Fund, one of the largest pools of capital on the planet, might repatriate overseas holdings back into yen-denominated assets. That speculation triggered a wave of carry trade unwinding, where investors who had borrowed cheap yen to buy higher-yielding currencies rushed to close their positions.

The underlying interest rate differential between the US and Japan, the gravitational force that keeps carry trades attractive, hasn’t meaningfully narrowed. That gap is what makes borrowing in yen and parking money in dollar-denominated assets profitable, and it remains wide enough to lure traders back in.

The Bank of Japan’s tricky balancing act

Japan’s central bank isn’t standing still. The Bank of Japan currently holds its policy rate at 1%, and Morgan Stanley forecasts hikes to 1.25% in October 2026 and 1.5% by March 2027.

This is the paradox at the heart of the yen trade. The BOJ is tightening, which should theoretically support the yen. But it’s tightening slowly, from an extraordinarily low base, while US rates remain elevated. The net effect, according to Morgan Stanley’s analysis, still favors yen weakness.

In late July 2026, coordinated US-Japan action around the 163 level provided temporary support for the yen. Morgan Stanley’s target of 163 is notable precisely because it sits right at that prior intervention threshold, suggesting the bank believes we’ll test those levels again before authorities step in once more.

What the carry trade rebuild looks like

Morgan Stanley’s strategists characterize the recent positioning flush as creating a cleaner slate for traders to rebuild exposure. Their September 8, 2026 report highlighted the resilience of carry trades even amid periods of yen strength, essentially arguing that each yen rally creates a better entry point for traders who want to go short the currency.

The risks Morgan Stanley is watching

The 150 stop-loss on Morgan Stanley’s recommended trade tells you something about the risk calculus. If USD/JPY drops below that level, it would signal the yen rally has more structural legs than the bank anticipates, and they’d want out.

Several scenarios could invalidate the thesis. A faster-than-expected BOJ hiking cycle would narrow rate differentials more aggressively. Actual, large-scale GPIF repatriation, rather than just speculation about it, would create sustained yen buying pressure. And any significant deterioration in the US economic outlook that forces the Federal Reserve to cut rates would compress the yield advantage that makes yen carry trades attractive in the first place.