Profit-Taking to Drive USD Valuations Lower Warn Morgan Stanley

Fresh analysis from Morgan Stanley has seen analysts at the investment bank call time on their bullish stance towards the US currency.

The US dollar has endured one of the more impressive rallies seen in global FX in recent times with all majors, including the British pound, feeling the heat.

And still, the USD remains undervalued by historical trend according to a number of analysts we are in touch with.

Despite the prospect of further dollar gains lying ahead, the path higher will of course not be smooth.

Calling Time on the USD Rally… for Now

Cracks in the pro-USD are starting to appear with one major investment bank telling us profit-taking could well take the wind out of the Greenback’s sails.

Morgan Stanley have told clients they are positioning for an end to the rally:

Ian Stannard at Morgan Stanley tells us:

“We expect a USD correction over coming weeks. US data has been somewhat soft recently, while there are signs of reflation and green shoots in Europe.

“This differential could drive investors to take profit on some of their long USD holdings. Given stretched positioning, this should drive a tactical USD selloff. “

However, Stannard cautions that he believes USD weakness will be short-lived, and followed by a resumption of the bull cycle.

Speculators Should Cut Back on Long USD Exposure

As analysts call time on the Greenback’s strength so traders are told reducing ‘long’ exposure to the unit is a preferred speculative approach.

Stannard says:

“We take off most of our long USD positions. We remain bearish on lowflationary currencies, and for this reason keep our long USD/THB position and add a long EUR/PLN position.

“We also like relative value trades on this theme, such as short SGD/INR. One of the main risks to a USD correction over the coming weeks is an escalation in European political tensions. To hedge against a deterioration in European politics, we enter a EUR/USD put spread.”

Only Half Way Through the Bull Cycle

The vast majority of investment banks we follow retain their long-term views that the dollar strengthening cycle still has further to go.

Indeed, “we think we are only halfway through the USD bull cycle. Growth and monetary policy differentials are likely to work in favour of the USD, and the fundamental drivers of USD strength have not changed,” Stannard tells us.

Forecasting GBP/USD at 1.38

Turning to the sterling-dollar exchange rate we hear Morgan Stanley analysts are maintaining a bearish stance on the currency pairing.

Commenting on the outlook the investment bank says:

“We still expect GBPUSD to reach 1.38 by the middle of the year but look for higher levels to sell at, given the risks building for a bit of a USD correction.

“The focus this week will be the BoE’s Inflation Report, which the market is likely to expect to be dovish, given the recent low CPI print (below 1%Y).

“Markets will be focused on whether the report suggest that the BoE will keep rates on hold for a bit longer, given the low inflationary environment.”

We argue though that a decline below 1.40 would be unlikely based purely on historical precedent.

We note that the last time the GBP/USD broke below 1.40 was in the early 1980’s when the UK was being subject to a sharp recession.

The picture is fundamentally different today with the UK leading the G10 in the economic growth stakes.

We also note that the Bank of England delaying interest rate rises is no longer the GBP-negative story it used to be.

Westpac have pointed out today that no less than 16 major central banks have cut interest rates or eased monetary policy so far in 2015.

Those Banks that sit tight on policy are suddenly left looking like hawks; exactly where we see the BoE being placed.

Thus we see a premium being afforded to sterling particularly as the risks of the US Federal Reserve pushing back their first rate hike in response to global rate cuts grows.