Morgan Stanley sees dollar risks skewed to downside as energy shock sensitivity fades

Morgan Stanley says dollar risks are increasingly skewed to the downside as FX markets grow less sensitive to energy war headlines, though refined product shortages remain a key upside risk for the currency.

Summary

• Morgan Stanley analysts say risks for the dollar are increasingly skewed to the downside, with FX markets becoming less sensitive to energy supply disruption headlines from the war
• Investors are shifting focus to longer-term themes, with Morgan Stanley saying there is broad agreement that the dollar has scope to trade at a deeper discount to rate differentials
• The bank is nonetheless cautious about turning outright negative on the dollar, warning that markets may be underestimating the risk of refined energy product shortages
• Such shortages could weaken economic data expectations and trigger risk aversion, both of which would traditionally support dollar demand

Morgan Stanley has flagged a meaningful shift in foreign exchange market dynamics, warning that risks for the dollar are increasingly tilted to the downside as investors grow less reactive to energy supply disruption headlines and turn their attention to longer-term structural themes.

In a note to clients, the bank's analysts said FX markets are displaying a diminishing sensitivity to news flow around the war's impact on energy supply, a notable development given the scale of disruption to Strait of Hormuz traffic and Iranian crude exports in recent weeks. Rather than trading on each new headline, investors appear to be stepping back and focusing on where the dollar should be trading relative to interest rate differentials over a longer horizon.

Morgan Stanley said it believes investors broadly share its view that there is meaningful scope for the dollar to trade at a deeper discount to those rate differentials, a framing that implies the currency has further to fall from current levels once the noise of day-to-day war headlines recedes.

The bank is not yet ready to turn outright negative on the dollar, however. Its key concern is that markets may be underestimating the risk of refined energy product shortages, a second-order consequence of the Hormuz disruption that has attracted less attention than the headline moves in crude benchmarks. A shortage of gasoline, diesel or jet fuel would feed directly into weaker economic data and could trigger a wave of risk aversion that historically supports dollar demand.

The tension Morgan Stanley identifies is therefore between a structural case for dollar weakness building in the background and a tactical risk that an underappreciated refined products crunch forces investors back toward safe-haven positioning. Until that uncertainty resolves, a fully committed negative dollar call remains premature in the bank's view.

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Bearish framing for the dollar, though Morgan Stanley stops short of a full negative call.

The key insight is the shift in FX market behaviour: investors are increasingly looking through energy supply disruption headlines and focusing on structural dollar weakness relative to rate differentials, a dynamic that suggests the greenback's traditional safe-haven bid during geopolitical stress is eroding. The caveat is significant for energy markets specifically: Morgan Stanley warns that investors may be underestimating the risk of refined product shortages, which could yet trigger a fresh wave of risk aversion and dollar demand.

Morgan Stanley says dollar risks are increasingly skewed to the downside as FX markets grow less sensitive to energy war headlines, though refined product shortages remain a key upside risk for the currency. For oil markets the refined products angle is worth watching closely, as shortages in gasoline, diesel or jet fuel would represent a second-order consequence of the Hormuz disruption that has so far received less attention than crude benchmarks.