Morgan Stanley expects the US dollar rally will be hard to sustain, predicting that the US-Europe interest rate differential will narrow and that the Iran war may weigh on the economy.

At the same time, the euro and the yen both fell by more than 2% during the conflict, as Europe and Japan both rely on energy supplies from the Middle East. Morgan Stanley strategists led by David Adams believe that the US dollar rising to this level is more likely a “bull trap”; the market has already priced in the inflation risk caused by rising energy prices, but has underestimated the negative impact on economic growth. The risk of stagflation puts central banks in a difficult position, and policymakers will need to make trade-offs, resulting in varying policy outcomes. Expand