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The U.S. Dollar Can Advance Into, and Through, the Next U.S. Recession

US Dollar outlook

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- The U.S. Dollar is set to rise for several years

- Fed interest rate hikes will support in 2019

- The Dollar could even rise in a recession

The U.S. Dollar will probably continue rallying for several more years according to an analyst with J.P. Morgan who sniffs a potential U.S. recession within two years.

"We are forecasting a greater than 60% odds of the U.S. entering a recession on a two-year forward basis. If that is the environment then we could be risk-off, which is usually Dollar positive," says James Sullivan, JP Morgan head of Asia ex-Japan equities.

It certainly looks to be a win-win for the Dollar over coming years as before any USD-positive recession does materialise, conditions will continue to be Dollar-supportive thanks largely to the U.S. Federal Reserve which will deliver its latest policy guidance on November 08.

The U.S. Federal Reserve, the body tasked with raising interest rates, will probably continue to raise rates at a relatively rapid pace in 2019. According to its own projections, Fed officials are expecting an average of three more 0.25% hikes in 2019.

Overall, an environment in which rates are rising by almost 0.25% per quarter is likely to benefit the Dollar, and Sullivan says, "we will see rates supportive of the U.S. Dollar through 2019."

Currencies tend to appreciate because of superior interest rate and growth differentials and these will continue to favour Dollar strength in 2019 as interest rates rise more rapidly in the US than other jurisdictions.

Rising interest rates tend to strengthen currencies because they attract greater inflows of foreign capital drawn by the promise of higher returns.

Fed Chair Jerome Powell has also been rather hawkish in recent comments. The Fed Chair said that he expected rates to rise to the 'neutral rate' or even slightly beyond. The neutral rate is the rate at which the economy is at 'equilibrium', neither growing nor shrinking. The Fed estimates this to be at 3.0%. The current Fed funds rate, meanwhile, is 2.25%.

Whilst the exchange rate can act erratically during the final hike in the Fed's overall tightening cycle, the Dollar will probably still rise after that from safe-haven demand as mentioned before.

J.P. Morgan is not alone in seeing interest rates continuing to rise, David Bloom, global head of FX at HSBC, is also hawkish.

Bloom's view is that the U.S. economy is "cooking, baby" and so in order to 'cool it down,' the Fed will need to continue to raise interest rates.

More importantly for the Dollar, the Fed will probably raise them at a faster pace than most other central banks, and the difference in pace is likely to lead to Dollar outperformance.

"The economy is cooking baby, you have got a pro-cyclical fiscal policy going on, you have the lowest unemployment rate since the 1960s, and the economy is doing very nicely; and he's tightening policy. No one else in the world is because their economies are getting crushed like bugs," says Bloom in a recent Bloomberg TV interview.

In so far as Donald Trump's criticisms of the Fed's aggressive tightening policy go, Bloom does not see it as a factor impacting the central bank's decision-making.

"Grow up! The Fed has to look after over 300m people in this country it is not just looking after your wallet," adds Bloom.

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