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“A tale of two worlds. We forecast 4% global GDP growth in 2010, but this masks two very different stories. One is a still fairly tepid recovery for the advanced economies. The other is a much more positive outlook for emerging markets, where we forecast output to grow by 6.5% in 2010. In short, we think that the themes of global rebalancing and EM growth outperformance have staying power and have even been bolstered by the crisis.”

                             Morgan Stanley Global Economic Forum

FX Trading – The yen will take back carry trade crown in 2010!
Any dollar bull story must consist of the Mr. Greenback relinquishing its role as carry trade currency i.e. primary major currency borrowed to fund risky asset and other high yielding investments. The Japanese yen, the all-time carry trade champ, looks like it is about to be anointed once again.

This recent note from the Financial Times Lex column summed it up well [our emphasis]:

“When you run out of things to say, shout. On that rubric, the Bank of Japan [BOJ] is yelling. In spite of holding the record for the consecutive number of years of deflation (seven), the BoJ has said it will no longer ‘tolerate’ falling prices. This is a sop to the government, which wants the central bank to help the economy. Judging by BoJ’s inflation forecasts, negative 1.5 per cent this year, minus 1 per cent next year and a 0.7 per cent drop in 2011, Japan has to tolerate deflation a while longer.

“The alternative is aggressive quantitative easing, a successful Japanese export little practised at home of late. Buying government bonds would help fund the budget deficit. With other central banks talking about exiting QE, however, it would also undercut the yen, which on Friday fell almost a cent. Shout? Somebody heard.”

Among the major currency pairs, we think being long USDJPY in 2010 will be the best single payoff. Key central banks are poised to drain the punch bowl in 2010. But the Bank of Japan will likely be the glaring exception to this rule. Thus, Japanese yen yields remain at enticing carry levels while US rates should be ticking higher across the curve.

USDJPY Weekly: