Investor risk appetite continues to fall according to Morgan Stanley’s index for such things, the ‘Global Risk Demand Index’. It still remains comfortably in positive territory however:
Thing is, they believe falling risk appetite could cause a short-squeeze for the dollar-bears:
Morgan Stanley’s Yilin Nie:
To be fair, the current level of 1.5 in the GRDI is still largely supportive for risk assets. And even if the GRDI continues to grind lower at a gradual pace, the current trend of USD weakness may persist based on lagging US growth and rate differentials. That said, if sentiment sees a sharper lurch to negative territory, there is a risk that we will see a bigger USD correction. [Read: a strengthening] Our positioning trackers, including the IMM and the MS Flows reports, show that USD net shorts have reached deep levels over the past few months (see Exhibit 5). Large positions like this are usually most vulnerable during bouts of deleveraging. Currently, the largest net long positions opposite the USD are AUD and MXN, as reported on the IMM. Our own flows also show a sizable USD/JPY net short base. Given a USD positioning squeeze, our sense is that these crosses would prove the weakest links.
Shorting the dollar has become a pretty crowded trade:
Even if the dollar is still looking weak in the long-run:
While acknowledging there is a technical risk of a USD correction here, we do not believe that a USD rally would prove sustainable in the long run. Fundamentals are still stacked against the USD, with the increasing probability of QE2 and a slowing economic recovery. This is a stark comparison to other economies. Compared with the US, China surprised with a rate hike this week and posted near double-digit growth for Q3. Similar contrasts can also be found against other EM countries.
(Via Morgan Stanley, FX Pulse, Yilin Nie, 21 October 2010)