Morgan Stanley is recommending clients sell the euro against the Australian dollar, targeting a drop to 1.53 with a stop at 1.69. The bank points to the widest G10 yield gap favoring the Australian dollar, low implied volatility, and overdone bets on further ECB tightening.
Morgan Stanley is telling clients to sell the euro against the Australian dollar, aiming for EUR/AUD to fall to 1.53 from around 1.6295 currently, with a stop loss set at 1.69. The bank argues the trade works best while foreign exchange volatility stays subdued, and it rests the call on one of the widest interest rate gaps in the G10.
A widening rate gap between Australia and the eurozone
The Reserve Bank of Australia has raised its cash rate three times in 2026, taking it to 4.35%, as it worked to contain inflation that has stayed persistently above target. The European Central Bank, by contrast, has moved only once this year, lifting its deposit rate by 25 basis points in June to 2.25%, its first increase in nearly three years and a decision driven largely by the Iran war's impact on eurozone energy costs and inflation. The resulting spread, roughly 210 basis points in the Australian dollar's favor, leaves forward implied Australian dollar yields the highest in the G10, Morgan Stanley says.
Why low volatility matters for the trade
That yield advantage matters most in an environment of low implied volatility, which is exactly the backdrop the bank sees at present. Carry trades, where investors borrow in a low-yielding currency to fund positions in a higher-yielding one, depend on calm markets to work, since a volatility spike can quickly erase the yield pickup through currency moves alone. With implied volatility running very low across FX options markets, Morgan Stanley expects this to keep attracting capital flows into Australia, reinforcing the case for the trade so long as that calm persists.
A second catalyst on the euro side
The euro side of the trade carries its own catalyst. Morgan Stanley argues markets are currently pricing in too much further ECB tightening, and that this view could shift lower as incoming data comes in. Should the implied ECB policy path move down, that would weigh on the euro independently of the carry dynamic, giving the trade a second source of downside beyond the yield differential alone.
Together, the wide rate gap, calm volatility conditions, and the potential unwind of hawkish ECB pricing form the basis for Morgan Stanley's view that the path of least resistance for EUR/AUD is lower from here.
Source: Investinglive
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