US dollar strength set to reassert itself, Morgan Stanley says

The US dollar's disconnect from the global reflation trade would likely prove short-lived, Morgan Stanley told clients.

As long as the US output gap continued to close as the economy improved, the investment bank said it would stick to its bias of being 'long' the US dollar against low-yielding currencies.

Indeed, recent weakness in the Greenback might stumble as soon as 1 February, when the Federal Reserve was next scheduled to issue a policy statement, it said.

"[Bear] in mind that US financial and monetary conditions have eased while data continue to come in on the strong side," Morgan Stanley said.

Admittedly, the new US president's "verbal currency intervention" had increased the risk premium and may have convinced some investors to lower their allocation to money market positions in dollars and raise those in dollar-swapped short-dated Japanese yen positions, analysts led by Hans W.Redeker said.

In parallel, short debt (Rinban) buying by the Bank of Japan might clear the way for downside in the yen, Morgan Stanley added.

Morgan Stanley also expressed a liking for 'quasi-China' shorts, pointing out that Australia's economy had failed to register the same economic surprises as other Developed Markets while recent readings on inflation Down Under had undershot market forecasts.

"Should the overbought commodity market head towards a correction, AUD may lose its final pillar of support."