Morgan Stanley calls dollar top, predicts end of Fed balance-sheet normalization

Morgan Stanley Research, part of the MS financial services group, said the US currency has likely peaked already and that the US Federal Reserve is likely to follow a more accommodative monetary policy going forward.

Fed Chairman Jerome Powell had softened his stance early this month after his December comments about balance-sheet normalization at the US central bank caused a sharp correction in global stock markets in December.

Following Fed’s December meeting, Powell had said that the central bank’s policy on reducing its balance sheet was “on autopilot”, meaning that it would continue with the reduction for the foreseeable future with low chances of human intervention.

The Federal Reserve is on a course to get rid of trillions of dollars worth of bonds and other securities it had purchased in the aftermath of the 2008 financial crisis to infuse liquidity into a frozen financial sector.

US Federal Reserve Balance Sheet – Last 10 years

The infusion of cash has largely been used for financial speculation in asset markets, including those for stocks, real estate, art and so on.

Stocks have risen to all-time highs and have been on the rise for around one decade.

Faced with the prospect of a sudden decline in asset prices threatening to upset the economy again, Powell earlier this month that the Fed is “listening carefully to the message that the markets are sending” and that the message will also be considered while making policy.

The Federal Reserve was trying to get interest rates back into the 5% range, after cutting it close to zero in the aftermath of the financial crisis.

However, the ‘withdrawal effects’ seen in global equity and real estate markets even as the central bank has reached only half of its raising cycle is widely expected to lead the Fed to freeze its plans.

“We think the Fed may struggle to keep the market happy: The Fed’s shift in tone to start the year is notable. But we see two challenges: 1) Rate markets that are already pricing cuts and 2) A larger-than-expected impact of balance sheet reduction,” Morgan Stanley said in its latest ‘Global Macro Forum’.

“We think the latter will lead to a surprisingly early end to balance sheet normalisation… reducing supply and supporting Treasuries,” it added.

MS said it preferred US and Canadian securities over those of the UK and Germany.


The prospect of higher interest rates in the US market had led to a sharp withdrawal of money from non-US markets to its home country.

This had led to a sharp increase in the value of the dollar, and proportionate decline in other currencies.

MS said that is also now likely to stop.

“In FX (foreign exchange markets), we think this means that USD has topped, and will weaken: We see broad-based USD weakness, against both low yielders (EUR, JPY) and EMFX (emerging market foreign exchange),” it added.

For equities, MS maintained that “we’re not out of the woods”. It said that global money supply, as measured by narrow money or M1, will continue to decline in the short term. M1 includes currency and overnight deposits.

“Global M1 growth doesn’t bottom until the end of March, and further earnings downgrades remain likely. Wait for a re-test of the December lows to buy the cyclicals,” it said.