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- Dollar forecast to weaken when Fed cuts rates
- This is likely to happen before year-end
- Trade war to impact both global and U.S. growth
The U.S. Dollar will eventually weaken when the Federal Reserve starts cutting interest rates, which is likely to happen in 2019 as the consequences of the trade-war bite, according to research from European lender Danske Bank.
“I believe USD strength will be over, particularly versus cyclical, risk-sensitive currencies such as the NOK, AUD and NZD,” says Dr. Thomas Harr, an economist at Danske Bank.
Although the U.S.-China trade war has actually so far been positive for the Dollar by boosting safe-haven flows into U.S. Treasuries, it could also have an offsetting downside impact on U.S, growth which could encourage the Fed to loosen monetary conditions.
This is now increasingly likely due to the negative impact of tariffs on the U.S. domestic economy.
Indeed, recent commentary from Fed officials Bullard and Powell suggests an interest rates cut may not be all that far off.
St Louis Fed president James Bullard explicitly called for a cut and Fed chairman Jerome Powell said the Federal reserve would ease monetary conditions if necessary to maintain current levels of growth, in the event a slowdown resulted from the deteriorating global backdrop.
The imposition of tariffs acts like a tax since it transfers money from consumers to the government. This means it has the effect of ‘tightening’ monetary conditions and unless this is accompanied by increased growth it can cause a slowdown.
If this happens the Fed is likely to have to step in to provide some offsetting help for the economy via an interest rate cut.
Danske sees this as probable in 2019, and it will bring the Dollar’s rally to an end.
When central banks cut interest rates it often has a negative impact on the currency. Lower interest rates are a less attractive draw to foreign investors and capital inflows start to dry up reducing demand for the currency.
The effect will be worse felt against cyclical, risk sensitive currencies such as the Australian Dollar and Norwegian Krone.
The impact of the trade-war on global growth has increased to a significant level. The decline in relations which accompanied the trade spat over Huawei was a “game-changer” for the global economy, says Harr.
Pre-Huawei, Harr had expected moderate cyclical global in late Q2 and Q3, but now he expects a downturn.
Although it is expected to slow it is not expected to be recessionary.
The global slowdown will affect China the most but the U.S. will also be impacted.
“I expect a mild US downturn, as US financial conditions have just tightened marginally, while I believe there is a good chance that the Fed will begin cutting rates from late 2019,” says Harr.
A really significant hit to the global economy would come from Donald Trump pushing ahead and imposing 25% tariffs on the remaining $300bn of US imports from China.
EUR/USD to be Lifted
China holds the key to the Eurozone’s recovery so their fates are entwined to a degree, says Harr “with China slowing again, I believe that the common currency area will slow modestly."
Greater European political and financial integration might help support the region by providing more affordable funding, however, such an eventuality looks far off given the continued strength of far-right nationalist parties.
Although the tail-risk of the Eurozone breaking up has probably now been dismissed, it is also a long way from integration, and Brexit is a short-term more concrete manifestation of this risk.
German bund yields are likely to rise more than U.S. treasuries and given the historically close correlation between their difference and EUR/USD this will probably result in a lift in the EUR/USD exchange rate during 2019.
“I expect US and core-euro interest rates to remain at current low levels for the time being, with the risk tilted to the downside for US rates,” says Harr.
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