Closer To The End Of The Risk Rally and Signals - Morgan Stanley

Over the past few weeks, markets have traded well, driven by a more dovish interpretation of the Fed’s rate path and a moderate rebound in data, notes Morgan Stanley.

"The initial selloff in the USD before the Chinese New Year holidays gave some space to the CNY and helped stabilise commodities to some extent, both of which helped sentiment toward EM currencies.

We think that trade is probably close to being over, as we approach the G20 meetings in Shanghai this weekend and markets realise the limited scope for policy co-ordination across monetary and fiscal policies. Indeed, US Treasury Secretary Jack Lew has already warned investors: “don’t expect a crisis response in a non-crisis environment”." MS argues.

"Two weeks ago we laid out our case for why we did not believe an agreement at the upcoming G20 to co-ordinate FX policy among the major central banks and governments was likely. Any deal would likely have resulted in a weaker USD, given the multiple benefits this would bring globally via easing pressure on the RMB, raising commodity prices and reducing tension in global credit markets.

But we believe the macro cycles and monetary policy impulses across the various major economies are simply not aligned in such a way that makes it possible for central banks to take the necessary measures to weaken the USD. Europe and Japan would push back while the US is thinking more about hikes rather than the unsterilized monetary easing required to weaken the USD.

Since then, the Chinese authorities have stated that a currency deal is highly unlikely, but there have been some suggestions that a fiscal deal might be in the offing to boost increasingly subdued global growth, particularly with both the IMF and OECD calling for co-ordinated action ahead of the G20 meetings, and the growing sense of urgency to reduce the over-reliance on increasingly unconventional monetary policy to help growth," MS adds.

"We think this fiscal deal is unlikely, and therefore recommend taking a more risk-negative stance in currency positioning," MS advises.

In line with this view, MS tightened the stops on some of its current FX positions such as its short EUR/USD from 1.1360. The trade now has a revised profit-stop of 1.1150 and a target of 1.0700. 

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