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With U.S. economic growth forecast to slow next year, the Fed is widely expected to take a break from hiking rates in the middle of 2019 which will weaken the U.S. dollar. But more importantly, large economies such as Europe, Japan and China are now investing less in global financial markets, so demand for the U.S. dollar will likely reduce, said Hans Redeker, Morgan Stanley's global head of FX strategy.
That's significant because the U.S. is running both fiscal and current account deficits, so the country needs buyers for the bonds that it sells. A fiscal deficit happens when a government's total spending exceeds the revenue that it earns, while current account deficit occurs when a country imports more than it exports.
"When you create debt, you need to find somebody to buy it. And that means you need to look into the global availability of capital and ... global availability of capital is in sharp decline," Redeker told CNBC's Sri Jegarajah on Thursday.
As a result, there will be less capital available to fund U.S. deficits, he said at the Morgan Stanley 17th Annual Asia Pacific Summit in Singapore.
Higher bond yields — partly a result of the Fed's rate hikes — and improved economic growth in the U.S. this year spurred investors to shift funds into the world's largest economy. That in turn led to an increased demand for the U.S. dollar, which has strengthened the currency for most of 2018.
So far this year, the dollar index — which measures the greenback against major foreign currencies — has inched up by around 4.9 percent. But Morgan Stanley has predicted that the index will fall from its current level of about 97 to 85 by the fourth quarter of 2019, and 81 by the end of 2020, according to the bank's latest Global FX Outlook report in November.
The greenback has strengthened this year on large inflows of foreign funds, but when investors find better returns elsewhere, there's a risk that they'll take their money out of the U.S., noted Redeker. That's especially true now that some emerging markets are starting to offer better returns relative to the U.S., he said.
Morgan Stanley earlier this week upgraded stocks in emerging markets from "underweight" to "overweight," and downgraded U.S. equities to "underweight." That stance was taken because the bank is predicting stable growth in emerging economies in 2019, compared to a slowing expansion stateside.