The US dollar exchange rate complex is rising again following weeks of persistent weakness. There could be more to come argues a leading independent economist.
The US dollar has been falling steadily since February, with the US dollar Index down from a peak of 99.93.
However, it is still expected to rally through to the end of 2017, according to research carried out by Capital Economics, the company set up by the Woolfson Prize winning economist Roger Bootle.
This view could go some way in answering the question as to whether or not the dollar has seen its peak of its current multi-year cyclical upturn.
Understanding the outlook requires a little understanding of the reasons the dollar's run higher has stalled' clearly if these issues fade away then the bulls can find their confidence once again.
In short, there are three culprits:
- the rise in commodity prices (which has supported commodity currencies)
- a radical revision of expectations as to when the Fed is likely to raise interest rates (from 1.0% to 0.0%)
- and the flight of capital to safe-have currencies, like the Swiss franc and the yen.
These factors pushing the dollar lower are not likely to last, however, argue Capital Economics.
The rally in commodities is unsustainable with oil unlikely to end the year higher than its current level at 40 dollars per barrel, the Fed will eventually start to raise interest rates in 2017 and demand for safe-havens will dry up.
It is only in 2018 that Capital Economics expect the dollar to come under significant pressure again.
“Despite its recent weakness, we don’t expect the dollar to continue to struggle through the end of 2017. One reason is that we think commodity prices are unlikely to surge – indeed, we doubt the price of oil will end this year much higher than it is now, while we think the recent rally in some industrial metals prices may prove unsustainable," says John Higgins at Capital Economics.
Another reason Higgins is confident on the dollar's outlook is he expects the demand for safe havens to fade.
"Perhaps most importantly, though, we continue to anticipate a much starker contrast than investors do in the monetary policies of the Fed and the other major central banks,” says Higgins.
Dollar has Already Peaked
The debate over the dollar's future is one of the most contested in the institutional analyst community.
J P Morgan Chase, for example, are a little less bullish the dollar, particularly in 2016, when they see the down-trend continuing versus most counterparts bar a few EM currencies.
In a recent note, head of global FX strategy, Daniel Hui argues that the dollar may have reached a cycle peak versus most currencies at the January highs, and from here on its down-hill as the dollar bear cycle begins:
“Following the spike in the broad dollar in January, we have progressively added to the list of currencies against which we expect the dollar has already peaked, particularly in the past month. Of the thirty-two currencies we forecast, we now only expect less than a third of them (ten to be exact) to make fresh lows against the dollar this cycle.”
Unlike Capital Economics who see oil remaining at its current 40 level, Hui and his team expect it to continue appreciating by 8.0% to 43 dollars per barrel by the end of 2017.
This will boost oil producer currencies such as the Canadian Dollar, the Russian Rouble and the Norwegian Krone and the Mexican Peso.
Their reasons for upgrading crude is as a result of a revision in their expectations of, “faster progress in US shale supply adjustment.”
Another reason for continued pressure on the dollar is expected to come from a stabilization in China which will end the Chinese Renminbi’s devaluation spiral versus the dollar:
“More signs of life in China’s investment stimulus and the PMI surveys led our economists to upgrade Chinses growth forecasts marginally to 6.7% (from 6.6%) in 2016. Combined with a more proactive approach towards managing capital flows and enforcing near-term stability currency, we have trimmed our USD/CNY year-end target to 6.75 (from 6.9).”
Not only China’s currency is set to recover, however, the rebound in the Renminbi is expected to lift Asian FX in general by 3.5%, further eroding dollar index strength.
J P Morgan see dollar gains against the yen and the euro as highly unlikely in 2016 (EUR/USD to end at 1.17, USDJPY at 103.0).
Falling Unemployment; Rising Inflation
A previously material possibility of the US economy falling into recession was a further reason for J P Morgan down-grading their dollar forecast, however, Hui admits that this may have been overly pessimistic, and there is still the potential for bouts of dollar strength due to the combination of rising inflation and falling unemployment, which could causing the Fed to increase interest rates earlier, thus stimulating interest in the dollar from outside investors seeking higher returns:
“At the same time, the degree by which the Fed has now been de-priced (with the first full hike not until deep into 2017) reinforce the idea that the episodes of broad dollar strength are still forthcoming this year, as continued expected grinds higher in core inflation, and grinds lower in the unemployment rate put Fed tightening back into play as an FX driver.”