The US dollar has been on a tear since bottoming at 93.73 on July 26, 2011.
On a trade-weighted basis, the greenback has rallied 30% over the past four and a half years, establishing its third "super cycle" since the late 19 70s.
Now, Morgan Stanley thinks the dollar is setting up for one "final leg higher," aided by macro developments outside of the US. Specifically, MS says the dollar rally will be driven by "EM currency weakness and related US capital inflows."
The bank believes EM must eliminate its output gap, or the difference between the actual output of an economy and its potential output.
Since the US has already eliminated its output gap and unemployment is at or near the non-accelerating inflation rate of unemployment (also known as NAIRU), or the level of unemployment below which an economy sees inflation increase, these factors should provide support for the dollar as they're likely to result in a tighter labor market and higher US wages.
So how far can the dollar run?
Morgan Stanley thinks the trade-weighted dollar will hit 135 by the end of 2017, good for another 10.7% rally from current levels.
At that point, the bank says the USD will "likely revert back to its status of being a funding currency for higher-yielding investment."
Here's a look at Morgan Stanley's forecast:
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