After the economy
The rise of the dollar in 2018 were provided with favorable fundamentals in the U.S. economy. At the end of the year she promises to show growth of 3% — the highest since the global financial crisis of 2008. One of the main drivers of this growth was the tax reform trump. Lowering corporate taxes from 35% to 21% contributed to a significant increase in corporate profits due to higher wages, increased consumption.
Net profit contributed to the increase in investment in the economy, and in the third quarter US GDP rose by more than 4%, which is ahead of the pace of the global average. This is logical provided the inflow in the American economy of capital, which supported the strengthening of the dollar.
One of the goals of tax reform trump was repatriation of profits by U.S. companies. Famous since the campaign motto America First load, and a Corporation that previously held assets abroad, began to return to the United States. For example, Apple has in foreign accounts as of the end of 2017 was stored more than $250 billion of available funds. Tax incentives had a positive impact on capital inflows and supported the dollar.
However, new fiscal incentives after the democratic victory in the elections to the lower house of Congress, however. The effect of the tax reform ends this year. Therefore, we can expect slowdown of capital inflows in the United States.
Against this background, naturally reduced the growth of the American economy. Although signs of a recession we do not see a slowdown from 3% to almost 2% per year is likely. In such circumstances, the US economy will lose competitive advantage from the point of view of investment attractiveness compared to other countries, and the dollar will react to this weakening.
At purchasing power parity, the dollar is significantly overvalued, and the economic slowdown may finally bring his course to a more fair level. High rates of economic growth in the U.S. gave the U.S. currency to weaken because of the continuing increase of the trade deficit. Although one of the arguments in favor of trump’s trade war with China was the need to reduce trade imbalances in the short term is unlikely, given his gigantic size.
Looks more real the threat of currency interventions, as the President of the United States has repeatedly said the priority of the weak dollar. The slowdown in the economy automatically increases the chances of strengthening the negative impact of trade deficit on the dollar.
Runing from the fed
The us currency also may lose support from the fed. The beginning of the year was marked by increased expectations of monetary policy tightening in the United States. The statement hardly came as head of the fed Jerome Powell in late winter about the excellent health of the U.S. economy has adjusted the forecasts of market participants on the number of raises in 2018.
In the end, the level of the base interest rate has been shifted four times, most recently following the meeting, on 18-19 December, although at the beginning of the year, the market on average had expected a maximum of three rounds of monetary policy tightening. Higher interest rates naturally increased the demand for the dollar.
At a press conference following the meeting of December 19, Powell has tried to lower market expectations the number of bets increases in 2019. Spot survey of members of the Federal open market Committee involves two rounds of monetary policy tightening, although in the previous fed meeting in September it was about three. Thus, the softening of the position of the regulator is evident.
Besides Jerome Powell said on the achievement rate of the lower border of the neutral level of 2.5%. The neutral level of rates this year was discussed several times, as the market wanted to know how far the controller is ready to go on the path of monetary tightening. The result was a marked range of 2.5-3.5%.
Therefore, the remark by the fed about reaching the boundaries of this range — a clear enough signal that the potential for raising rates on the dollar. Consequently, the attractiveness of the dollar could decrease in comparison with the other currencies for which bids with high probability will begin to rise next year. ECB completes asset purchase program, while the Bank of England is going to increase long bets on the pound, but while this prevents Brexit.
The prospects for growth
The risk of such a scenario can be called the deteriorating economic conditions in the world and stronger growth in the United States that will force the fed to raise rates in 2019, at least three times.
In addition, more imminent than it appears today, the onset of a US recession which will have serious negative consequences for the global economy will strengthen demand for safe assets. One of them is the dollar, so the search for “safe havens” outweigh all other factors and will contribute to the continuation of the rally in the U.S. currency.
However, while we estimate the likelihood of a US recession in the next 12 months approximately 15% and not see the obvious threats to continued growth.
As the final argument in favor of weakening the dollar is worth to mention the “herd instinct” of market participants. Bank of America Merrill Lynch called it is no coincidence that the dollar is the most popular trading idea.
Recent data from the report of the Commission on trade commodity futures (CFTC) also suggest a large number of positions in the dollar. The index near the highs of the end of 2016, followed in 2017 began the long fall of quotations of the American currency.
Thus, in our view, the situation is in favor of weakening the dollar in the next year. Investors should prepare for this now and to reduce the share of dollar-denominated securities in their portfolios. Diversification is never superfluous.
The weakening dollar can have a positive impact on the stocks of U.S. companies that get most of the revenue abroad. So it is possible that in the coming months, stocks FAANG and the dollar will be swapped and profitability, not only in the place in the ranking Bank of America Merrill Lynch.