Morgan Stanley reiterates its USD bearish base case, but highlights that a supply-driven surge in oil prices is an important upside risk to the Dollar, potentially triggering a short squeeze in what remains a consensus short USD market.
Key Points:
-
Supply-Side Oil Shock = Short Squeeze Risk:
• A geopolitical supply shock that pushes oil prices sharply higher could lift the USD by ~2% or more, given crowded USD short positioning.
• Near-term, this could limit investors’ appetite to add USD shorts or increase exposure to oil-sensitive FX pairs. -
Parallels with March 2022:
• The market is increasingly trading FX based on terms-of-trade dynamics, similar to the reaction after the Russia-Ukraine war began in March 2022.
• Historically, the DXY peaks and then weakens quickly after geopolitical escalations, implying that any USD rally driven by oil could be short-lived. -
Positive USD-Equity Correlation:
• The strong correlation between USD and US equities may also cap any significant, sustained USD strength. -
Medium-Term Bearish USD Fundamentals Remain:
• US rate convergence, hedging flows, and weaker relative growth still point to a weaker USD in the medium term.
• MS sees a geopolitical-driven USD squeeze as an opportunity for USD bears to re-enter at better levels.
Conclusion:
Morgan Stanley argues that while higher oil prices are a real short-term risk to the bearish USD view, any USD strength on the back of an oil-driven short squeeze should be seen as an opportunity to fade and re-establish short positions, as fundamentals continue to favour a weaker dollar into 2025.
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