Investing.com – Amid a bout of very strong gains that has pushed the main dollar index to its highest levels since February 2002, Morgan Stanley (NYSE:) is warning that the dollar’s strong rally ends in a major crisis.
“The recent rally in the US dollar has created an unsustainable situation for risky assets including stocks,” Morgan Stanley said.
And the bank continued, “This rise and that excessive strength of the dollar has led in the past to some kind of financial or economic crisis, according to one of the most pessimistic Wall Street pessimists.”
Michael Wilson, chief US equity strategist at Morgan Stanley, wrote in a note, referring to the 2008 global financial crisis, the 2012 sovereign debt crisis and the end of technology – a stock bubble in 2000.
Wilson sees a “definitive decline” for the benchmark S&P 500 that will come later this year or early next level at the 3,000 to 3,400-point level.
That means a drop of 13% halfway, the benchmark futures contract fell 0.7% on Monday and in turn rose in early trading around 0.6%.
A stronger dollar hurts the value of US companies’ international sales, with Morgan Stanley calculating that every 1% change in has a negative 0.5% impact on earnings.
“S&P 500 earnings for the fourth quarter will face headwinds of an approximate 10% from the stronger currency, as well as other issues such as higher input costs,” Wilson said.
“The reaction to FedEx Corp’s warning earlier this month showed that significant earnings disappointments are not yet assessed according to consensus estimates,” said the strategist, who correctly predicted a decline in US stocks this year.
Meanwhile, Bank of America (NYSE:) strategists, citing EPFR Global data, said investors are flocking to cash and are shying away from nearly every other asset class because they have become the most pessimistic since the global financial crisis.
Surprisingly, such dollar strength is occurring even as other major central banks are also tightening monetary policy at a historically tight pace according to Morgan Stanley’s Wilson.
Lisa Chalet, chief investment officer, Wealth Management at Morgan Stanley, says the US dollar was in a tailspin, before growing 14% in 2022 compared to the basket of currencies. There are several main reasons for its rise:
Investors find the dollar to be a safe haven in times of market volatility.
The US economy has held up better than the economies of other countries.
US inflation-adjusted interest rates are on the rise, thanks to one of the fastest Fed rate hikes in recent history.
Reasons for concern
What is worrying, however, is that the dollar’s relative strength is now somewhat stiff as the dollar is at a 20-year high against the other major currencies.
The pound fell to its lowest level against the dollar since 1985, while the yen recently reached its lowest level since 1998, trading below par, something that hasn’t happened since 2002.
This strong relative strength of the dollar could lead to bouts of instability, similar to the 1997 market-based Asian debt crisis or the growing trade imbalances that led to the 1985 Plaza Accord, in which the United States agreed to weaken the dollar to reduce those imbalances.
However, investors don’t seem to appreciate the risks, as market situation data shows that investors around the world still prefer the dollar and expect it to continue to strengthen, Lisa Chalet said this is worth a note of caution, as markets may find themselves in a disorderly breakup when the dollar hits The end to the top.
There are three specific risks to consider: Lisa Chalet, chief investment officer, wealth management at Morgan Stanley, says:
Currency extremism threatens corporate profits.. For US companies with business in other countries, including many in the S&P 500, a stronger dollar reduces the value of their foreign earnings when converted into dollars.
At the same time, the global competitiveness of US companies is at risk, as products become more expensive in terms of local currency, and these factors may be more acutely felt in the coming months as global demand is likely to slow, but they do not appear to be recorded in the 2022 earnings estimates or 2023.