FYI | Jul 10 2006
By Terry Hughes
Like many other currency experts, the economists at Morgan Stanley expect the US dollar to fall, but they certainly do not subscribe to the "dollar must fall no matter what" theory.
While the economists agree with the view that the US dollar will continue its cyclical decline "reflecting the real economic slowdown" they argue that this will likely be curbed by "liquidity driven risk-reduction," so the dollar will, in their view, not fall as far as some others are predicting.
The US Fed had been expected to stop its tightening phase at around 5.25% or 5.5%, but some are now speculating that it could go as high as 6% this cycle, which has "forced a violent wave of risk-reduction in May and June," Morgan Stanley says.
Risk reduction is positive for the US dollar, the broker argues as it sees the currency as a "safe haven" from the perspective of emerging markets. The economists are also of the view that US real money accounts are still out of balance and are in fact overweight risky assets such as emerging markets, as well as in the Nikkei and European markets, which further supports their view.
Additionally, when Asian investors look to de-risk they tend to shift into US dollar-based investments and out of their own local currencies, which is also expected to provide support for the greenback.
However, with the Bank of Japan (BOJ) likely to end its zero interest rate policy sometime soon, Morgan Stanley expects the USD/JPY to at least cap at around current levels, but this obviously assumes that the US Fed stops at 5.5%.
When in comes to the yen’s relationship with the NZD, AUD and INR, the economists feel that the repatriation of investments could lead to material enough reflows of funds to cause these three currencies to suffer.
Furthermore, they expect commodity currencies to weaken as the global economy slows down and as such they expect the USD to strengthen against the CAD, AUD and NZD later this year and in 2007.
As for other Asian currencies, the broker feels "reasonably healthy risk taking appetite" should allow them to strengthen against the USD, although the prospect of a higher than expected Fed interest rate and higher US inflation means their forecasts have become more modest.