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The dollar should make a decisive turn lower by autumn, according to Morgan Stanley, which would allow the pound and other major currencies to rally.

In a mid-year strategy update, Morgan Stanley analysts expect greater strength in the Northern Hemisphere summer, though that strength is expected to be modest and would raise questions about more bearish predictions from the analyst community for levels below 1.20.

The Morgan Stanley research comes as the exchange rate between the pound and the dollar (GBP/USD) remains caught in a long downward trend driven largely by the seemingly unstoppable appreciation of the dollar since May 2021.

Last week, the dollar index – a measure of the overall performance of the USD – hit a 20-year high at 105.00, with corresponding multi-year lows of 1.0348 in EUR/USD and 1 .2155 in GBP/USD.

The declines have led some analysts to warn that GBP/USD is likely to test the psychological level of 1.20 in the near future.

“We expected the USD to continue to strengthen in 1H22 as rising US real yields and hawkish Fed policy would propel a narrative of ‘policy divergence.’ Market expectations for the Fed have certainly moved in that direction, but a surprisingly weak global growth outlook and geopolitical uncertainties have bolstered USD by more than expected,” said Matthew Hornbach, global head of macro strategy at Morgan Stanley.

A number of headwinds to the global economy have emerged this year, including Russia’s invasion of Ukraine, soaring inflation, central bank interest rate hikes and Chinese lockdowns. of Covid.

“We expect these trends to continue through the summer with modest but broad-based USD strength in 3Q22 pushing the DXY to 105,” Hornbach said.

At the time of writing, the Dollar Index (DXY) is at 104.53, GBP/USD is at 1.2345 and EUR/USD is at 1.0442; therefore, a retest of the 2021 highs could mean a test of last week’s lows for these two pairs once again before the end of the year. (Set your exchange rate alert here).

“The combination of lingering geopolitical uncertainties in Europe and Covid lockdowns in Asia should continue to fuel the ‘growth divergence’ narrative while North America, with the continued policy normalization of the Fed and the BoC, economic insularity, healthy local balance sheets and high savings, may be more immune to the perceived global slowdown,” says Hornbach.

But, “nothing gets worse forever,” he adds.

Morgan Stanley analysts expect the US dollar to top in early fall, which would cause the DXY to top, but not break out, of its long-term range.

Morgan Stanley Dollar Index Forecast

Above: “We expect the DXY to peak at 105 in 3Q22, the top of its long-term range” – Morgan Stanley.

This should be reflected in a number of key exchange rates such as GBP/USD and EUR/USD holding brackets.

Morgan Stanley argues that central banks cannot continue to push aggressively into restrictive territory and that global economic data will not worsen further relative to relatively pessimistic expectations.

Furthermore, the odds of a global recession are unlikely to increase any further and commodity prices and inflation will prove unable to accelerate at their recent pace.

“A reduced likelihood of Covid lockdowns in Asia and unexpected resilience in European data in response to the commodity price shock would also support a USD spike,” says Hornbach.

Morgan Stanley expects the euro-dollar rate to continue to decline in the short term, falling to 1.03 in the third quarter “and possibly even above parity as concerns over local geopolitics and commodities escalate significantly. significant”.

However, they expect the exchange rate to start rebounding slightly in the fourth quarter and into 2023.

The pound-dollar exchange rate is expected to remain in the 1.20 range, according to Hornbach, falling to 1.22 in the third quarter before pushing to 1.28 in mid-2023.