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The overwhelming bearishness surrounding the dollar is unnerving Morgan Stanley strategists, who argue that the extreme positioning could see the greenback’s selloff slow down.
That could present a tougher backdrop for global equity markets that have rallied in sync with the greenback’s decline.
Read: Here’s what the dollar’s fall means for the U.S. stock market
“As equity markets have rebounded, the dollar has fallen and recently fell to 3.6 standard deviations oversold on the same measure, the lowest level since 1978,” says a team of Morgan Stanley analysts led by Matthew Garman, in a Friday note.
They remain bearish on the dollar in the medium term, but for now have turned neutral on the greenback, exiting their short dollar position last week.
Led by the euro’s rally, the greenback has weakened since its peak of the market panic around the COVID-19 pandemic, when a rush to safety amplified a mad scramble for dollars. The ICE U.S. Dollar Index DXY, +0.71% is down nearly 3% this year, and is matching levels last seen more than 2 years ago. The index was in rebound mode on Friday, however, surging 0.8%.
If the greenback starts to consolidate its losses this year, it could make it difficult to take away a key tailwind for global equities that have benefited from the weakness in the world’s reserve currency.
Morgan Stanley noted the correlation between the Dollar Index and the MSCI All Country World Index 990100, +0.16%, which tracks the performance of international equity markets, was at its most negative in 7 years.
A negative relationship means the two assets tend to move in opposing directions.
Since their March lows, the S&P 500 SPX, -0.36% and Dow Jones Industrial Average DJIA, -0.27% have both rebounded nearly 50%. The MSCI ACWI index ACWI, -0.85% has also seen a 46% increase since this year’s nadir.
