Morgan Stanley Explains Why The US Dollar Is The Hottest Currency In The World Again

The US Dollar is HOT.

Here’s a chart of the trade-weighted dollar index. You can see it rallied in 2012, and has gone nuclear in 2013.

So what gives?

Dollar strength is the topic of this evening’s Morgan Stanley FX Pulse.

The basic gist is: It’s about weakening yen, strengthening data, increasing US yields relative to the rest of the world (which makes the dollar inherently more valuable), weakening euro, and more hawkish tones from Fed folks.

Here’s the commentary from Morgan Stanley:

There has been a significant shift in global currency market dynamics over the course of the past week, driven not only by the JPY, but increasingly by the USD. We have discussed recently the potential change in the status of USD, with the US increasingly being seen as an investment destination and the USD being used less as a funding currency.

This process has continued over the past week, with further strong data from the US leading to a renewed rise in US treasury yields. This rise in US yields now places the USD into the basket of yielding currencies, which suggest further support is likely to
build over the over medium term.

The US data has continued to provide positive signals for the USD, with the renewed improvements in the labour market data of importance, given the Fed’s policy link to the
unemployment rate. But, the positive news is broadening beyond the labour market, with a favourable impact on the US consumer also starting to become evident, while our US
economists now see US Q2 GDP tracking at 1.8% instead of 1.2%

The encouraging news from the labour market and elsewhere in the US economy has added to the USD support, especially as the tapering debate is intensifying once again. Indeed, most of the Fed speakers over the past week have been from the more hawkish camp, which has allowed the rise in yields to go unchecked, thus far. The Fed’s Plosser, although not a FOMC voter currently and a known hawk, has led the calls for
tapering over the past week. Hence, we place emphasis on Fed chairman Bernanke’s response (next speech due Saturday). If Bernanke decides to address the rise in yields
this could cause a pause in the USD recovery, but we would view this as likely to be very brief, providing a renewed USD buying opportunity, especially given the overall more positive signs of growth coming from the US economy.

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