Dollar set to lose ground this year
The dollar remains at high levels against a broad range of currencies.
After losing ground in 2017 and early 2018, the dollar has recovered strongly since last spring. The currency was aided by robust US economic data last year, at a time when other economies were slowing.
Widening interest rate differentials and bond spreads also helped the currency as the Federal Reserve continued to steadily increase interest rates. Rising risk aversion in financial markets was also supportive of the highly liquid US currency.
Escalating tensions over global trade, difficulties in emerging markets and geopolitical concerns all sparked flights-to-quality into safe-haven currencies like the dollar. It also benefitted from a big jump in the repatriation of funds by US companies last year to take advantage of cuts in US corporate taxes.
However, the US currency has found it difficult to make further gains since the autumn. It is now at quite elevated levels against a range of currencies, which may be limiting further upside potential.
The US economy is also expected to slow in the coming year, causing the Fed to adopt a cautious approach to further rate increases, and its next move could be a rate cut.
Nonetheless, the relative strength of the US economy, volatile financial markets, wide interest rate differentials and geopolitical uncertainties all remain supportive of the US currency.
Meanwhile, political uncertainty in the EU, a general rise in euro-scepticism, the slowdown in the eurozone economy and continuing very low ECB interest rates are all headwinds for the single currency.
However, there has been strong support for the euro against the dollar at the $1.13 level in recent months. Indeed, it has risen to around $1.15 in the past week on the view that we are near the peak in US rates. Overall, we think the dollar may lose some ground this year, while still remaining at a relatively high level.
The marked jump in the repatriation of funds, following the cuts in US corporate taxes earlier last year, is likely to abate. A US-China trade deal could be agreed in the spring, which should improve risk appetite in markets.
Meanwhile, there should be potential for the euro to rise over the medium term as the ECB begins to hike interest rates. However, while the euro has made some modest ground against the dollar in the past week, large gains seem unlikely in the near-term.
