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Investing.com -- The dollar’s bruising slide to two-year lows this week has some betting on a rebound, but Morgan Stanley (NYSE:MS) warns the bears aren’t ready to loosen their grip just yet. With widely expected U.S. rate cuts later this year and the greenback’s safe-haven status under fresh scrutiny, the bank says more pain could be in store for the dollar.
“We forecast that the US dollar (USD) will continue its year-to-date depreciation, driven by both fundamental and technical factors. Fundamentally, a convergence in US growth and interest rates weighs on USD, while increased FX hedging and continued debates around USD’s safe-haven status increase USD’s discount to fair value,” Morgan Stanley strategists said in a recent note.
Bets on sooner Federal Reserve rate cuts were given a boost on Tuesday after chairman Jerome Powell didn’t rule out a July rate cut, saying the central bank’s decision would be led by incoming data. Following the remarks from Powell, traders are now pricing in a roughly 23% change of rate in July, up from about 20% a day earlier, according to Investing.com’s Fed Rate Monitor Tool.
While odds still point to no rate cut in July, traders are now closely watching the nonfarm payrolls report due Wednesday for any signs of significant weakness in the labor market that could tip the Fed’s hand into an earlier cut.
Technical factors are also amplifying the dollar’s decline. As the incentive for global investors to hedge U.S. assets rises and the cost of FX hedging falls, Morgan Stanley expects hedge ratios for U.S.-held assets—especially European holdings of U.S. equities—to climb, adding further pressure on the greenback. “The more consistent and persistent this positive correlation [between USD and US equities], the greater the incentive to hedge,” the strategists said.
Even after this year’s drop in the greenback, dip buyers aren’t likely to emerge as the dollar remains at the upper end of its long-term historical range. The real broad USD index is still about 15% above its long-run average, and above the 90th percentile of its historical range. That, Morgan Stanley says, means the recent selloff isn’t enough to justify a bullish turn: “Citing the extent of year-to-date declines as a reason for hitting pause on USD shorts isn’t a persuasive argument considering the longer-run historical context.”
For all the rumblings of a dollar comeback, Morgan Stanley says the bears are still in control. With U.S. rate cuts looming and safe-haven demand fading, the greenback’s slide may have further to run.