Morgan Stanley is very DXY bearish.
The US dollar has remained remarkably stable in recent weeks.
Even the political noise surrounding potential personnel changes at the Federal Reserve and the decline in front-end UST yields have not rattled the greenback.
This resilience stems in part from a perception that the US economy is absorbing import tariffs more easily than expected, with US equities outperforming global peers once again.
This could be leading investors to conclude that the dollar’s much-discussed bear market is already over.
That impression is reinforced by less encouraging news elsewhere, with an increasing focus on the impact of tariffs on growth in Europe and Asia, while investors remain uneasy about fiscal health in several economies and bond supply looms large in their minds.
Although these arguments may seem persuasive, we believe they ignore the bigger-picture outlook for USD.
In short, we are not convinced that the dollar’s downtrend has run its course – on the contrary, we think its decline is barely halfway through.
We believe that investors should be cautious about dismissing the risks that a shift in Federal Reserve policy poses to USD.
Our US economics team believes the Fed is now more willing to live with the threat of higher inflation.
If market rates are guided further lower, while inflation remains stubbornly above target due to a gradual but persistent pass-through of tariffs to consumer prices, real yields would erode, a historical headwind for the dollar – a key insight from my colleague David Adams’well-known four-regime framework.
Morgan Stanley’s baseline view is that US GDP growth will slow to around 1% by 4Q25 and remain only marginally higher in 2026.
These growth rates hardly suggest US growth will outperform the rest of the world.
Friday’s weak labour market report suggests hiring has stalled, highlighting the downside risks to growth.
Against this backdrop, the risks of the market pricing more Fed easing are substantial.
Matthew Hornbach and the US rates team remain long the 5-year USTreasury note, reflecting our view that the front end of the curve could price a deeper cycle.
Lower rates would also further incentivise the hedging of USD assets held by foreign investors – a shift in investor behaviour we expect to contribute to a weaker USD.
While the Fed has lowered the bar for cutting, the European Central Bank has raised it and the Bank of England has recently struck a more hawkish tone – a combination that supports USD weakness.
Questions of governance and institutional independence are also present in investors’ minds – factors that have historically supported USD’s value by bolstering its position as the world’s primary reserve asset – a status that the CEA Chair and nominee to the Federal Reserve Board of Governors Stephen Miran believes comes at some cost to the US.
These are not bad arguments. If DXY is only halfway down, then that implies another 11% fall.
As noted many times, the AUD has clearly underperformed on the upside over the same period, only rising 6.5%.
If DXY were to fall so far, commensurate upside at this pace would take it to 70 cents.
Given the headwinds for the AUD, in structurally hopeless growth, the looming terms of trade smash with iron ore, and more severe labour impacts owing to AI than in the US, I expect this underperformance to continue.
My upside target for AUD is 0.68 cents before those headwinds turn the battler down again.
MS is not far off.
