Morgan Stanley Warns Soaring Dollar Teeing Up ‘Something to Break’ in Markets

A woman holds U.S. dollar banknotes on May 30, 2022. Dado Ruvic/Illustration/Reuters

The recent surge in the U.S. dollar could soon lead to some kind of economic or financial crisis, according to Michael Wilson, chief U.S. equity strategist at Morgan Stanley.

Wilson said in a note that even though such events are hard to predict, conditions are “in place” for the dollar to trigger such a development, according to Bloomberg. The rally has created an “untenable situation” for risk assets like stocks. “What’s amazing is that this dollar strength is happening even as other major central banks are also tightening monetary policy at a historically hawkish pace,” Wilson wrote.

“If there was ever a time to be on the lookout for something to break, this would be it.” Earlier in 2022, Wilson had accurately predicted that U.S. stocks would decline this year.

The U.S. Dollar Index has jumped by 19 percent this year, while stocks have fallen by 23 percent. A rise in the value of the U.S. dollar negatively affects the international sales of American companies.

A 1 percent change in the U.S. Dollar Index is calculated to have a negative 0.5 percent impact on company profits, according to Morgan Stanley. Wilson believes stronger currency and factors like high input costs will affect S&P 500 Index fourth-quarter earnings by around 10 percent.

In the week ended Sept. 20, speculators in the International Monetary Market had a net long position in the dollar worth $10.23 billion, according to Reuters. This was the sixty-second straight week that traders were holding long positions in the dollar, which is its third-longest streak since 1999.

Eric Leve, chief investment officer at wealth and investment management firm Bailard, believes such trades are going to trigger a decline. “We could easily see a 10–15 percent move the other way in the dollar versus the euro or the yen.”

Dollar Sales, Future Moves

In a Sept. 27 tweet, Cathie Wood, CEO and founder of Ark Investment Management, noted that Japan and China have sold U.S. dollars to protect their currencies against the American currency. The two Asian nations have begun putting out more dollars into the financial system.

“Japan’s and China’s dollar sales could be the first sign that ‘monetary easing’ is on the way. The dollar’s parabolic move has been devastating to the rest of the world and should come back to bite U.S. competitiveness, jobs, and economic activity, forcing the Fed to pivot,” Wood wrote.

The dollar’s rise is being supported by investor expectations that the Federal Reserve will continue raising interest rates. The Fed has indicated its commitment to fight against elevated inflation even at the risk of causing economic pain.

According to a Reuters poll of 70 foreign exchange strategists conducted earlier this month, the dollar is expected to remain strong for the remainder of 2022 due to rising interest rates and a strong economy. The currency is, however, expected to give up some of its gains in 2023.