How trade and interest rates will determine where the dollar ends 2018

0
229


The U.S. dollar and the euro have switched places as market favorites in the first half of 2018, leaving investors wondering which currency will be on top at year-end as they grapple with global trade tensions and a Federal Reserve that’s leaving other major central banks behind when it comes to raising rates.

Coming into 2018, investors favored the eurozone’s shared currency thanks to the strong economic growth the region had exhibited in 2017 — a performance that helped the euro rally around 14% against the dollar. But after the Federal Reserve completed its first, and highly anticipated, interest rate increase of the year in March, the tables turned, as eurozone data showed signs off sluggishness and the U.S. economy picked up steam. Traders began favoring the dollar and the euro retraced the gains it had registered earlier in the year.

See: Here’s how the ECB just breathed new life into the dollar rally

“If I was to simplify, the primary change was that while in 2017 there was a clear consensus about an upswing in global growth, Q1 threw a wrench into that [strong euro] narrative,” Derek Halpenny, European head of global markets research of MUFG, told MarketWatch.

The ICE U.S. Dollar Index












DXY, -0.74%










 rose 2.7% in the year to date, while the euro












EURUSD, +0.9249%










 dropped 3%, according to FactSet data. Here’s a look at what analysts watch in the next six months.

Check out: The dollar won’t win the ‘triple crown’ in 2018, Pimco says

Trade wars

Trade relations between the U.S. and its major trade partners have taken a beating in recent months. And while there is so far more bark that bite in terms of tariffs and other actions, currency traders are fear the world is edging closer to a trade war.

Read: Here’s what currency traders should remember when dealing with geopolitical risk

If the currently threatened tariffs were implemented across the board by the U.S. and its allies, the North American Free Trade Agreement — which has been under renegotiation since August last year — broke down entirely, and additional bilateral tariffs with China came into effect, stock markets would correct lower and worries about the impact of global growth would spike, Halpenny said.

So far, one major byproduct of the trade war worries has been a stronger dollar against export-reliant emerging market currencies. But with mounting concerns, the euro could function as a haven currency for those who want to get away from the buck.

”It remains our base case that trade wars would reinforce a push towards other reserve currencies like the euro, Japanese yen and Swiss franc,” wrote TD Securities strategists led by Mark McCormick. Japan’s












USDJPY, +0.32%










 and Switzerland’s currencies












USDCHF, -0.6217%










 are more traditional haven assets that investors flee to in times of uncertainty.

But the euro has already performed well in uncertain periods during the Trump administration, Halpenny added. Further, the eurozone current account surplus is one of the largest in the world, and that’s a key factor for a haven currency.

One complication in this scenario, however, is that Germany is one of the world’s largest auto exporters, Halpenny pointed out. Trump just recently zeroed in on car and car-part imports to the U.S., which could hit Germany where it hurts and ruin the euro’s chances at being the trade war safe haven.

The reflation theme

Besides trade, monetary policy will remain a key factor for the dollar and the euro in the second half of the year.

The Federal Reserve is moving full steam ahead toward monetary policy normalization, outpacing its peers. The U.S. central bank has raised rates twice already this year, and adjusted its forecast to call for possibly two more hikes before year-end. 2019 could bring another three increases.

“While the current monetary setting is still understood as accommodative, the Federal Reserve anticipates that policy will become more restrictive by the end of next year,” said Brown Brothers Harriman’s Marc Chandler and Win Thin.

“If we indeed get additional rate hikes in September and December this year, we would have seen five consecutive quarters of increases,” Halpenny added. And in light of the wobbles in global growth, this doesn’t seem like a sustainable path going forward.

U.S. Treasury bond yields












TMUBMUSD10Y, -0.26%










 are an indicator for interest rate expectations and can push the dollar higher. But since breaching the 3% mark in May, the yield on the 10-year note has fallen back. The flattening yield curve — the difference between shorter and longer-dated Treasurys — would be a major headwind for a sustained dollar rally, the TD strategists said.

Check out: Here’s the argument against freaking out over a flattening yield curve

Meanwhile, the European Central Bank is lagging behind, having just told investors in June that the eurozone wouldn’t see higher interest rates until at least summer 2019, which inspired a rally in the greenback.

“The ECB has taken out the topside of the euro into year-end but we look for a break of $1.20 later this year as the data confirms that quantitative easing is on the way out,” McCormick said. “For now, this backdrop lends itself to a short volatility structure in the euro, as the market awaits the data.”



Source : MTV