Morgan Stanley say there are new lows still to come for the US dollar

Author: Eamonn Sheridan | Category: News

From MS' weekly 'Pulse' reseach piece on why the USD will keep falling

In brief:

On global growth:
  • Continued global economic strength and low volatility have remained asset price supportive
  • Savings surpluses in Asia (ex China) and Europe
  • Expansionary monetary policies adding further support via ample liquidity.
  • Nominal growth continues to rise relative to funding costs, creating strong incentives for leverage and yield-enhancing trades.
On liquidity and carry:
  • DM bond yields are unlikely to rise materially without central banks increasing their tightening efforts or global savings falling
  • The Fed's transparent, gradual tightening approach parallels the 2004-2006 cycle, though over that period, the real 10Y rate had to rise to 2.5%, 200bps above current levels, before the carry trades reversed
  • The EM-US real yield spread has rarefy been this supportive, and thus the EM rally is likely to continue.
The USD should act as the main funding currency along with the CHF
  • we argue the EUR and JPY no longer qualify as funding currencies
  • Back-end rates now matter more for markets than front-end rates, and long-dated yield differentials should favor EUR and JPY
  • QE and tight fiscal policies have reduced foreign holdings of EUR-denominated assets, but foreign ownership of USD assets has actually gone up
  • If US rates rise (against our expectation) or US assets underperform, the foreign investors in these assets may begin to rethink their overseas exposures
  • Thus, US rates and USDJPY may no longer rise in tandem.

Trading
  • Unlike Japan's current account surplus, which is largely driven by the income balance, Switzerland's current account is largely a function of trade. This surplus has largely been recycled back into low-yielding domestic assets, causing CHF strength. Rising European returns are leading to a change in this process, suggesting to us CHF weakness. This week, we buy NOKCHF and sell GBPJPY.


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