Morgan Stanley shifts to buy-the-dips dollar stance, yen call unchanged

Morgan Stanley's strategy of buying on dips indicates that any dollar softness could be temporary, particularly if energy costs or a flight to safety re-emerge. The negative outlook on the yen keeps USD/JPY near the top of its trading band, where the possibility of Japanese currency intervention increases, especially with US authorities highlighting yen depreciation. Selecting the Norwegian krone over the euro and Swedish krona links currency exposure to oil market dynamics, making the Nordic currency a potential winner if tensions in the Middle East disrupt supply. For the euro, the positioning adds to strains from widening French bond spreads and the region's vulnerability to energy bills.

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A fortnight after acknowledging its dollar forecast had been incorrect, Morgan Stanley has tempered its bullish dollar call to a 'buy the dips' approach, retaining the trades that perform well during an energy crisis.

Summary:

• Morgan Stanley holds a neutral dollar view with a bullish tilt, seeking opportunities to buy on dips.
• The bank continues to be bearish on the yen, anticipating that carry trades will keep USD/JPY elevated.
• It prefers long positions in the Norwegian krone versus the euro and Swedish krona as protection against rising energy costs.
• In late September, the bank's strategists acknowledged their weak-dollar outlook was wrong and upgraded their dollar forecasts.
• A disappointing September US jobs report has since lowered the probability of a Federal Reserve rate hike in October.

Morgan Stanley has adopted a neutral stance on the US dollar with a bullish bias, indicating it will seek to buy on weakness, while remaining pessimistic on the Japanese yen and favouring the Norwegian krone against the euro and Swedish krona as a hedge against increased energy prices.

This position represents a retreat from the more aggressive dollar-bullish perspective the bank's currency analysts embraced less than two weeks earlier. In a late September note, a group led by David Adams admitted their earlier projection of a declining dollar had been mistaken. They had anticipated US interest rates converging with international rates as the Federal Reserve paused, but elevated oil prices, strong US economic data and a more restrictive Fed drove markets to expect rate increases, boosting the dollar.

At that point, the firm increased its year-end forecast for the dollar index to 102 and lowered its euro projection to 1.12 against the dollar, forecasting additional dollar appreciation into mid-2027 because of fiscal and political uncertainties affecting Europe.

Circumstances have shifted a lot since then. A poor September US payrolls report last week substantially diminished expectations for an October Fed rate rise, eroding some of the immediate support for the dollar's advance. The current neutral view with a bullish lean appears to match that change, preserving the overall case for a strong dollar while preferring to purchase on declines rather than pursuing gains.

The yen perspective represents a continuation of the bank's earlier stance. In late September, Morgan Stanley advised maintaining long dollar-yen positions from roughly 158, with a target of 163, and stated that dollar increases would predominantly occur against low-yielding currencies used for carry trade funding, including the yen, euro and Swiss franc. The substantial interest rate differential between the US and Japan continues to make borrowing in yen appealing for financing higher-yielding trades.

The krone call stems from Norway's role as a significant energy producer. A strengthening krone typically aligns with rising oil and gas prices, whereas the euro and Swedish krona are more susceptible to increasing energy import expenses, rendering this trade a safeguard against additional energy disruptions.

Morgan Stanley has additionally cautioned that dollar long positions could be unwound by sudden events, such as intervention to prop up the yen.