"We Were Wrong": Why Did Morgan Stanley Revise Its Dollar Forecast?

Morgan Stanley raised its year-end target for the dollar, acknowledging that its forecast of further weakness in the U.S. currency had not materialized. MarketWatch reports this.

"We were wrong," the bank's team of currency strategists, led by David Adams, stated in a note published on September 25.

The DXY Dollar Index reached an eight-week high this week amid rising Treasury yields and an increased likelihood of further Fed rate hikes. According to CME FedWatch, traders currently estimate a 68.6% probability of a 25-basis-point rate hike at the Fed’s October meeting and a 54.8% probability at the December meeting.

Morgan Stanley raised its year-end target for the U.S. Dollar Index (DXY) from 96 to 102 points. The bank’s analysts also revised their forecasts for major currency pairs: EUR/USD—from $1.20 to $1.12; GBP/USD—from $1.38 to $1.30; and USD/JPY—from 157 to 159 yen per dollar.

By mid-2027, Morgan Stanley expects the dollar index to stand at 104 points. They also forecast that the euro will weaken to $1.10 amid concerns about the fiscal and political situation in Europe. The bank recommended that investors maintain a long position in the USD/JPY pair from the 158 level, with a target of 163 and a stop-loss at 150.

Previously, Adams’s team had expected the dollar to continue weakening in the second half of the year, bottom out toward the end of the year, and only then begin to rise in 2027. This scenario was based on a convergence of interest rates in the U.S. and abroad: it was assumed that the Fed would pause while other central banks “caught up” with it in terms of the pace of policy easing. According to the bank’s analysts, a weaker dollar would also make hedging currency risks cheaper for foreign investors concerned about the long-term status of the U.S. currency, which would further accelerate its decline.

The situation was altered by high energy prices, solid U.S. economic data, and the Federal Open Market Committee’s (FOMC) hawkish response to rising inflation. These factors led the U.S. central bank not only to raise rates for the first time in three years but also to signal the possibility of further rate hikes, the bank’s strategists noted. In their view, the market is capable of pricing in rate hikes beyond what is justified by fundamentals, and this provides additional support for the dollar.

Morgan Stanley clarified, however, that the dollar’s rise will be driven primarily by low-yielding currencies used to finance carry trades—the yen, the euro, and the Swiss franc, as well as the British pound, while commodity currencies such as the Australian dollar and the Norwegian krone will remain strong. The bank acknowledged that the expected movements are not particularly large: the market probability of the euro falling to 1.10 against the dollar by mid-2027 is already estimated at about 35%, meaning the event appears quite predictable for investors. Strategists also warned that long positions in the dollar could suffer from unexpected shocks—such as Donald Trump’s “Liberation Day” or currency interventions by Japan.

"We are concerned that long positions in the dollar could be forced to close due to an unexpected shock in the future, even though the fundamental arguments in favor of its strength are more compelling, and the most likely outcome is that the dollar will strengthen over time,", according to a Morgan Stanley note.

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