That is one of the main thrusts of Morgan Stanley’s freshly released outlook for 2013, which predicts the changing status of currencies is going to be one of the main themes in FX next year, as cyclical factors erode the position of risk-on/risk-off as the dominant force in the market.
Ian Stannard, head of European FX strategy at Morgan Stanley, says the USD has a traditional dual role as a safe haven and a funding currency.
“However, in the current lower global growth environment, there is potential for the USD’s role to shift away from being used as a funding currency to becoming a destination for investment,” he says.
With growth differentials between the US and the rest of the world shrinking and interest rate differentials reduced, there is less of an incentive for US investors to seek returns overseas, according to Stannard.
In addition, with the Federal Reserve looking to target growth by supporting asset prices, the relative outperformance of US markets should provide an incentive for domestic investors to keep their funds at home, he says.
US 12-month rates compared to G10 average carry and USD index
Source: Morgan Stanley, Bloomberg
Such regime shifts for the USD are not uncommon. Those tipping points, according to Morgan Stanley, tend to occur when US yields exceed the average carry returns available in G10.
While that point has not yet been reached, the difference between US yields and the average G10 carry is now starting to drop sharply, implying the incentive to use USD as a funding currency is falling.
Stannard adds that if the JPY starts to re-establish its position as the funding currency of choice within the G10, then that could spark a rotation from USD into JPY funding positions.
“We not only maintain our view that the current USDJPY rally is sustainable, but also believe it could lead the way for a broader USD recovery,” he says.
Morgan Stanley has a 12-month target of ¥90 for USDJPY, $1.20 for EURUSD and $1.54 for GBPUSD. The bank expects AUDUSD to break down below parity to $0.96.