Morgan Stanley: No Dollar Rebound Until Late 2010

Morgan Stanley reads the tea-leaves post-Bernanke’s speech on Monday, and basically says there’s nothing to worry about.

Intervention not imminent.  We believe that a key reason why policymakers have not translated their talk into action is that the USD decline has been orderly and backed by fundamentals.  In Bernanke’s speech, he characterises the USD moves as a ‘retracement’ from abnormal levels. Indeed, in the big picture, the USD’s current decline (15% from the March 2009 high) has not even offset the surge in the US TWI seen in late 2008 (25% from March 2008 to March 2009, see Exhibit 1).  As Bernanke suggests, that surge was largely sparked by the safe haven bid during the financial crisis.  Since then, USD depreciation has been persistent but orderly.  Amid shifting market dynamics, it is rare for policymakers to intervene unless moves become extreme or unjustified. 

According to our proprietary FX intervention model, the risk of intervention is still elevated at 28%, but has receded significantly since the start of the year when the reading was 53% (see Exhibit 2).  Also, the factor in our model that is contributing to the elevated  intervention risk stems from divergences in growth differentials. Importantly, the indicators of momentum and  positioning are not at extremes.

Despite the growing verbal pushback, our central case is that the USD trough is not in place yet.  Official jawboning may slow the downward momentum, but fundamentals warrant further currency weakness.  Until growth and rate differentials move in favour of the US, the USD will have difficulty putting in a bottom, in our view. Going into next year, we forecast another 4% depreciation in
the US TWI before a reversal in late 2010. 

This is consistent with 1.60 in EUR/USD and 1.01 in USD/CAD (see FX Forecasts on page 22).  Notably, we do not anticipate a USD crash and also judge the bulk of decline to be behind us.  In a
recent note, we outlined four factors that would make us bullish on the USD — (1) sooner than expected hikes by the Fed; (2) faltering in the global economy; (3) a rekindling of risk aversion; and (4) steps by the government to reduce future deficits (see USD: What Would Make Us Bullish? 1 October
2009).  We continue to monitor these risks but judge them to be low probability events for now.

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