US dollar headed higher, Morgan Stanley says

The US dollar was likely headed higher as a result of the easier fiscal policy which the new US administration appeared to have in mind, Morgan Stanley said.

Nonetheless, the investment bank stressed that the lack of comparable historical episodes of increased government spending when unemployment was already low meant uncertainty around its possible effects was higher than would otherwise be true.

"There is little precedent for where we're likely to head, supporting the idea that 2017 has an unusually wide distribution of outcomes," strategists Andrew Sheets, Phanikiran L Naraparaju, Serena W Tang and Wanting Low said in a research report sent to clients.

In the event, the strategists said they saw some parallels with both the late 1960s and mid-1908s, explaining that low unemployment with easing policy has been "a poor combination" for corporate credit, albeit a better one for the US dollar.

Looking to the latter of those two episodes, Morgan Stanley highlighted the fact that the US dollar index jumped 25% over the year to early 1985, supported by US growth, high interest rates and more inward-looking consumption on the back of protecionism.

"Of course, this period proved to be the last hurrah for the dollar until at least the early noughties, but that short period in the mid-1980s when fiscal spending met an improving, protectionist economy, leading to a stronger USD, chimes with our view for continued dollar strength for the next 12 months."

Morgan Stanley projected the US fiscal deficit would rise from roughly 3% of gross domestic product at present to 5.8% by 2018.

Among other things, that would push unemployment in the States down from 4.7% to 4.4%.

Worth noting, in the early 80s the Reagan administration implemented several protectionist measures, including import quotas and a 45% tariff on Japanese automobiles.

For their part, in a research note issued on the same day strategists at Bank of America-Merrill Lynch highlighted the contradiction apparent between Trump's mooted trade policies - which required a weaker US dollar - and his fiscal plans, with the latter being inherently dollar positive.

However, the boost to the greenback was more of a longer-term issue, BofA-ML said.

Nonetheless, a reduction in the rate of corporate income tax incorporating a so-called 'border adjustment' would see the US dollar strengthen by 25%, offsetting the benefits of fiscal stimulus, they said.

"Moreover, the required rise in USD is also very much a purchasing-power-parity-style argument, which is a good guide for the longer-term, but expectations of an instantaneous full adjustment feel overdone. And even if the FX adjustment was instant, it feels peculiar that a new 25% rise in USD has generally been discussed in policy circles in a fairly casual manner. Our current forecasts actually do not have much net change in G10, but would have to incorporate a far stronger USD, especially in the longer-term, if Border Adjustments were adapted."