Core Conclusion: Target Price Still Points to 1.23, but Short-term Volatility May Return
In its latest strategy report, Morgan Stanley maintains an upward view on the Euro/USD exchange rate, projecting that it may rise to around 1.23 by the second quarter of 2026. The firm also cautions that if macroeconomic data once again takes center stage in the market, short-term fluctuations might increase. However, medium-term risks for the dollar remain high, so they have not switched to an extremely bullish "more optimistic" scenario.
Why the Dollar is Weak: Interest Rate Differentials Aren't Explaining It Properly
The report suggests that the recent weakness of the dollar is atypical: traditionally, the interest rate differentials driving G10 currencies have not provided equivalent guidance. Morgan Stanley focuses on "unconventional catalysts"—factors that have increased the dollar's risk premium to relatively high levels since the second quarter of 2025. The issue is that such catalysts are often difficult to quantify and predict, yet they continue to dominate trading, thereby reinforcing the euro’s phase of strength.
The "Cost" of a Strong Euro: Dual Constraint on European Assets and Macroeconomics
Morgan Stanley warns that euro appreciation does not only result in favorable "book appearances." For European markets priced in local currency, a strong euro could erode corporate profits through conversion effects: the firm estimates that every 5% rise in the euro/USD could reduce the annual profit growth rate of the MSCI Europe Index by approximately 1.5–2 percentage points.
On a macroeconomic level, if the euro appreciates by 5% in trade-weighted terms, eurozone exports could decrease by around 1.5%, and economic growth might be dragged down by about 0.3 percentage points.
Faster Impact on Inflation: "Cooling Effect" through Energy Transmission
On the inflation front, the firm assesses that the impact of euro appreciation may manifest more quickly, particularly through channels of imported energy prices. The report suggests that if the euro/USD shows a cumulative increase of 10%, eurozone inflation could be reduced by about 30 basis points over the next two years. For the market, this means that exchange rates not only affect asset returns but might also alter the marginal slope of inflation paths and policy expectations.
