Morgan's currency call

By Karen Remo-Listana
Wednesday, December 31, 2008
www.business24-7.ae

The dollar is set to head higher in the first half of next year, before giving back some of its gains in the second half, assuming the global economy bottoms next summer, a report from Morgan Stanley said.

"As the world cycles through summer, fall, winter and spring, investors can anticipate various cyclical currency trades. US dollar strengthens as the world slows, but will weaken as the world recovers," said the report, sent to Emirates Business. And since the world is likely to enter deeper into the "winter" season, the dollar should strengthen further. But when "spring' comes, the dollar is likely to give back some of its gains.

"In 2009, assuming that the global economy does find a trough by summer, we see the dollar rallying further into the trough, but underperforming most other currencies as the world recovers in the second half," it said.

Through its "Four Seasons'" currency concept, the New York-based investment bank said real global economic growth and equity buoyancy demarcate four distinct scenarios for the world, further noting that different currencies tend to perform best in these four quadrants.

The US Treasuries will likely remain well supported while a flare-up in inflation is not a probable risk, the report added.

There are two main risks however to Morgan Stanley's dollar view – inflation and an unsustainable federal debt profile.

The Fed's QE operations, it said, need an exit strategy. The latest talk of the Fed issuing its own debt may be one way the Fed could unwind its balance sheet in time to stabilise inflation expectations.(Bennie Bucks to the rescue? - AM) In addition, the dollar's performance will be driven by inflation expectations.

Similarly, the super-sized US fiscal deficits will be a risk for the dollar, though it views the US Treasuries are more likely to be a preferred safe haven asset in a global recession, marginalizing other sovereign debt.

On the other hand, Morgan Stanley says emerging market (EM) currencies are 'summer' currencies that do not perform well in 'winter' while euro – historically a "winter" currency – will suffer because of possible fractures in Eastern Europe.

"EM currency 'moment' is not over, in our view," it said. "In fact, the process is roughly halfway complete. We see weaker Latam currencies in the first half. Pressures on AXJ currencies will likely persist, as these countries' exports collapse and their central banks cut interest rates. We believe that even the Chinese yuan will be allowed to weaken against the dollar in the coming months."

It said Eastern European currencies may come under intense balance of payments pressures while the situation in Russia especially deserves investors' full attention, as "the familiar structural fragilities of Eastern Europe will expose the broad region to possible discrete changes in the rouble" it said.

It remains bearish on the euro in the first half. "Though the euro is no longer over-valued, it is still over-rated and over-owned," it said.

"We would not be surprised if the world's reserve holdings of British pound and Swiss franc start to decline from here, with the euro being a beneficiary of this prospective new trend," Morgan Stanley said.