USD to recouple with rising yields and strengthen against low-yielding currencies, says Morgan Stanley

The US dollar (USD) is expected to recouple with rising Treasury yields and strengthen against low-yielding currencies. The reflation trade remains intact. The Morgan Stanley, an American multinational financial services corporation in its report mentioned that the President Donald Trump's comments about USD strength to sustainably impact USD and think sustainable USD weakness would only come from disappointment on the policy front.

Also, we at FxWirePro expect that the USD to strengthen in line with the receipt of more detail on the new US government’s fiscal stimulus plans and probably other tariff and tax measures during Trump’s first 100 days in office.

If Trump moves towards protectionist policies, we still expect USD strength (particularly from border adjustment). However, these USD gains would be disproportionately against EM currencies.

The United States dollar index is likely to continue its post-Presidential election merriment even in 2017. We foresee that the dollar index (DXY) will jump above 107 by the first quarter and break April 2002 high of 115 by the end of next year.

Also, we expect that the gains in dollar index will be above the Euro for the first time in 14 years. Not only are US interest rates on the way up in contrast with the rest of the developed world, but long-term rate differentials will continue to widen to record levels.

The economic growth in 2017 is also likely to remain moderate in the near future between 2-2.5 percent supported by Donald Trump’s fiscal stimulus in the form of rising government spending, expanding military and tax cuts.

Following this, the Federal Reserve will be forced to hike interest rate further in 2017. We foresee that the central bank will hike 25 basis points thrice next year- first in June, second in September and the last as usual in December. This will further boost demand for U.S. dollar.

Moreover, it is worth noting that the rising demand for U.S. dollar is mainly because of Donald Trump’s fiscal spending appeal, which is expected to be financed from government borrowing and not because of growth in U.S. economy.

If Trump successfully implements his fiscal plan, consumer inflation will surely rise, giving the Federal Reserve wider space for an interest rate hike. Thereby, rising Fed fund rate will increase the cost of borrowing. After the Presidential election result, dollar index witnessed a massive buying, sending the DXY higher by 8 percent to 103.62 in just a month’s time.

Lastly, we expect the DXY, which recently broke to 14-year highs to rally by more next year and then break its 2001-2002 record of 120 later in the cycle.