Morgan Stanley: Don't Get Excited, More Dollar Pain Is Coming

Earlier we brought to you Citi’s note on the ongoing dollar weakness.

Now, Morgan Stanley:

Into year-end we think that the USD will probably weaken further perhaps helped by strong seasonals (Exhibit 1). The ECB continues to be hawkish with some board members continuing to talk about exit strategy and while it doesn’t appear that Europe really needs tighter policy yet, this is likely to support the Euro especially against a backdrop of the Fed adding more stimulus.


ndeed, while the euro has suffered on sovereign concerns we suspect that the Irish problems will soon be resolved with some form of bailout as all concerned will be keen to prevent further unnecessary contagion to Portugal. Even more importantly, policymakers will want to contain any issues within Ireland/Portugal from afflicting Spain, where the cost of any potential bailout would be too much of a burden for the Eurozone. While these problems are unlikely to go away they perhaps won’t weigh on the euro much further into year end. Next year of course the story could to be different.

At the same time the spotlight has also returned to the US economy. The recent backup in 10-year yields has caused some stresses in the system highlighting the possibly that the economy cannot withstand rising interest rates along with the rising debt burden. Strains have emerged notably in the municipal bond market. Yesterday AAA 10-year municipal bonds had their biggest one-day selloff since the financial crisis, in October 2008, rising by 18bps.

Recent macroeconomic data have also highlighted the uphill task ahead for the Federal Reserve in achieving their dual mandate. The latest consumer price inflation data disappointed expectations, remaining flat on the core measure on a monthly basis and up only 0.6% on a year ago (Exhibit 2). The latest evidence on the housing market was also problematic with the housing starts dropping 11.7% on the month and building permits also disappointing expectations in October (Exhibit 3).


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