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Morgan Stanley says it has “doubled down” on its bearishness towards the U.S. Dollar in 2023, prompting it to lift its Pound to Dollar exchange rate forecast.
However, analysts at the investment bank say U.S. Dollar weakness will be most pronounced against Euro and risk-sensitive currencies such as the New Zealand Dollar and Canadian Dollar.
Morgan Stanley says in a research briefing update that the macroeconomics forces that were once constraining Dollar weakness are now amplifying it.
“Global growth is showing signs of buoyancy, macro and inflation uncertainty are waning, and the USD is rapidly losing its carry advantage,” says James Lord, Global Head of FX and EM Strategy at Morgan Stanley.
The growth outlook has improved amidst the reopening of the Chinese economy as authorities abandon the zero-covid policy and expectations that the Federal Reserve will end its rate hiking cycle within the first quarter of 2023.
The research update comes as a much-watched survey of global fund managers reveals the Dollar is still a favoured ‘long’ amongst institutional investors, suggesting further potential downside as the view unwinds.
The latest Bank of America Fund Manager Survey finds the “long Dollar” trade is still said to be the most crowded position – 32% of responses – followed by long ESG assets (17%) and long China equities (12%).
The same survey also indicates investors are shifting out of U.S. assets at their fastest pace since October 2005 as they seek opportunities in Emerging Markets, the European Union and UK.
This shift to the Rest of the World from the U.S. underscores the sizeable macroeconomic shift identified by Morgan Stanley that is driving Dollar weakness.
“Global growth is less anaemic than expected with European and Asian data increasingly likely to lead the outperformance,” says Lord. “The USD’s carry advantage is being eroded by higher yields abroad such as in Europe and Japan.”
Above: Morgan Stanley spot G10 FX forecasts versus consensus.
Morgan Stanley says it looks for outperformance against the Dollar to come especially from the New Zealand, Australian and Canadian Dollars, as well as the Krone and Euro.
But the Pound is not expected to join this club: “we are more sceptical that GBP can rally alongside other risk-sensitive currencies given domestic growth challenges and its balance of payments environment,” says Lord.
He adds that while the Dollar’s relatively higher carry partially erodes total returns, he expects total returns for most G10 currencies to be positive relative to the Dollar, except for the Yen and Pound.
Despite a relatively sober approach to Sterling, Morgan Stanley nevertheless raises its point forecasts for the GBP/USD exchange rate to 1.20 for the end of the first quarter of 2023, from 1.13 previously.
The target for the end of the second quarter is raised to 1.20 from 1.14 previously and for the end of the third quarter, the target is raised to 1.21 from 1.15.
For year-end, the target is 1.21, up from 1.16 previously.
If this view is correct then the rally in the Pound against the Dollar peaked has ultimately peaked in the first two weeks of 2023.
Morgan Stanley strategists are however more bullish on the Euro’s prospects and hold a long EUR/USD trade that targets 1.15 by year-end.
They also hold a long NZD/USD trade that targets 0.68 and a short USD/CAD trade that looking for a decline to 1.28 by the end of the year.
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