Morgan Stanley
  • Thoughts on the Market Podcast
  • Dec 8, 2023

Contrarian Call on the U.S. Dollar


Welcome to Thoughts on the Market. I'm Dave Adams, Head of G10 FX Strategy at Morgan Stanley. And today I'll be talking about our views on the U.S. dollar. It's Friday, December 8th at 3 p.m. in London.

The U.S. dollar has fallen about 4% since it peaked in October and has retraced about half of its gains since July. We think this correction should be faded and we're affirming our call for Euro/Dollar to fall back to parity by the spring of next year, meaning the U.S. dollar will rise a further 8% versus the Euro.

This is a controversial and out of consensus call, but we think the market is still underpricing weakness in Europe and strength in the U.S., and a continued widening in growth and rate differentials should weigh on the pair.

A lot of investors claim that the U.S. dollar should weaken further as the US economy slows from its growth rate this summer. We agree U.S. growth is likely to slow, but by far less than investors think. Our U.S. economics team thinks the U.S. growth will be about 1% stronger than consensus estimates, with the biggest gap for data leading into the second quarter of next year. This is a dollar-positive outcome.

We also hear from investors a lot that weakness in Europe is fully priced, but we respectfully disagree. Sure, there's a lot of cuts priced in for the European Central Bank, but not as much as there should be once the ECB more formally acknowledges that cuts are coming..

The real risk here is that markets begin to price in ECB rate cuts below the long-run estimate of the neutral rate of 2%, and in a world where the ECB is cutting, this is a real possibility.

A fast and deep cutting cycle in Europe would sharply contrast with the Fed, whose rhetoric continues to emphasize higher for longer, a view amplified by strong domestic growth. Divergence in economic data between Europe and the US should keep the euro falling versus the greenback.

Now, I'm the first to admit that an 8% move in a few months time is a pretty big move and moves that large don't happen that often. If we look at options pricing, the market is pricing in an even lower risk of such a move compared to historical frequencies. And it's worth remembering that large moves do happen. Eurodollar fell 10% in a four month window two different times last year. So while this call may be bold and buck consensus, we think the fundamental story still holds.

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Will the U.S. dollar weaken further as the economy slows? What will its value be compared to the Euro by spring 2024? Our analyst tackles those key currency questions and more.

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