The Tell: This could the beaten-down dollar’s route to a rebound, Morgan Stanley says

Many a currency strategist is bracing for prolonged U.S. dollar weakness due to upbeat global growth expectations and signs central banks around the world are moving toward ending ultraloose monetary policies. Still, the greenback might have one more trick up its sleeve according to Morgan Stanley analysts, and it all comes down to international trade.

Trade is set to be the big topic of 2018. Aside from interest rates, it’s all that seems to be on currency strategists’ minds these days.

Trade rhetoric has taken a protectionist turn of late, with President Donald Trump right at the helm in threatening to end trade agreements, such as the North American Free Trade Agreement between the U.S., Canada and Mexico. There is also increased talk of sanctions targeted at China and others.

Read: Investors are getting a taste of China’s 2018 policy agenda

This tougher stance is “providing the potential catalyst for the dollar to regain some lost ground,” wrote Morgan Stanley analysts led by Hans W. Redeker.

On Friday, the ICE U.S. Dollar Index DXY, -1.08%  fell 1% thanks to a strong euro and British pound. The index has now been in the red for four weeks in a row.

“The recent news suggesting a rising risk of protectionism, in a market environment of stretched risk asset positioning may be the impetus for a correction in risk and a temporary break in the dollar’s weakening trend,” they wrote.

One recent example of that is the Mexican peso USDMXN, -1.2395% which has displayed volatility due to the Nafta renegotiation talks. This week, Canadian officials were quoted as saying that they increasingly expected a U.S. withdrawal from the trade pact. It is widely accepted that Mexico would be worst off if the agreement was terminated.

Other currencies that are most vulnerable to downside risk are those sensitive to trade and a current-account deficit figures, the Morgan Stanley analysts said, citing the Canadian dollar USDCAD, -0.4633% as well as the British pound GBPUSD, +1.3886%

In turn, it would bode well for reserve currencies such as the dollar and the Japanese yen USDJPY, -0.20% they added.

“Ultimately, we view this as temporary, but from a tactical perspective, we see value in trading these dynamics,” the analysts said.

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