Morgan Stanley: The Dollar Is Vulnerable, and Will Stay So

The US dollar is vulnerable, and will continue to be so, concludes Stephen Jen, writing in Morgan Stanley's Global Economic Forum. While the greenback hovered in a range in the first two months of the year, it is now clearly weakening across the board, he continues.

According to the report, certain recent developments have not been supportive of the dollar:

• A hyper-proactive Fed: Jen notes that the current Fed has been more aggressive in the past six months than its predecessors in the six months prior to the onset of the eight U.S. recessions since WWII. Furthermore, Ben Bernanke's testimony to Congress last week indicated to the market that the Fed would not hesitate to ease further if the economic outlook deteriorates.

• A resilience in the rest of the world: Traditionally the U.S. economy has affected the rest of the world, with a time lag. Even so, recent data were "on balance, on the strong-side, suggesting that the world might de-couple from the US, at least temporarily."

• Fear of stagflation: Jen considers this fear "compelling" and likely to put the Fed under greater pressure than other central banks. Furthermore, even if a recession were to be avoided in the U.S., he believes that inflation could "very well become a genuine threat."

Jen reaches the following conclusions:

The dollar will be vulnerable against the EUR in the coming weeks, and against many EM currencies in the coming years. While there is certainly scope for investors to establish fresh speculative dollar shorts against the EUR and GBP, I remain troubled by the already high valuation of these currencies. Therefore, I continue to see the EUR and GBP ending the year significantly lower than their values at the start of the year.

Comments

[whidbey]

Yes, currencies are vulnerable in general since its a three party trade, buyer, seller and government. Governments are betting the farm so-to-speak. Add to that the Euro is not only technically overvalued, but politically vulnerable to EU intervention to preserve competition. Finally, even members of the EU dislike the Euro as a currency unit. This is not a place for casual hedging.