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U.S. Dollar Will Rise Further in 2019 as Analyst Community gets "Trampled Again" say HSBC

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- USD to rise in 2019 as Federal Reserve tightens further say HSBC. 

- Even if the Fed pauses rate hikes, USD could still go on rising in 2019.

- Sceptic reticence means analysts in danger of being "trampled again".

The Dollar will strengthen further in the coming year and is a "buy" under most scenarios, according to analysts at banking titan HSBC, who warned this week that the analyst community is about to get "trampled again" because of its reticence toward the U.S. currency.

There are three possible scenarios that could play out for the Dollar over the coming year, the bank writes in its latest review of currency markets, and in two of them investors would be best served by either buying the greenback or simply ensuring that they are not stood in its path as 2019 gets under way. 

"Having failed to forecast the USD bull run of the last five months, the consensus is steadfastly sticking to its view that the USD will weaken, pencilling in roughly a 6% depreciation over the next twelve months," says David Bloom, head of currency strategy at HSBC. "The consensus is no doubt bruised and hurting, and we believe they may be about to get trampled again. This is an unloved USD bull run."

A superior U.S. economic performance has enabled the Federal Reserve to go on raising its interest rate at a time when many other central banks are sat on their hands due to economic underperformance or sub-par inflation.

The Fed is expected to raise its interest rate again at the end of September, while the Bank of England, European Central Bank, Reserve Bank of Australia and Reserve Bank of New Zealand are all expected to stand pat well into 2019.

This goes a long way toward explaining why the U.S. Dollar, after declining 4% in the first-quarter, has triumphed over all other developed world currencies barring the Swiss Franc and Japanese Yen so far in 2018. 

"The Fed could continue to defy the market’s dovishness and deliver rate hikes above the ‘neutral’ rate, and consistent with the “dots” path," says Bloom, referring to Fed projections for its own interest rate. "US rates are high enough to continue to suck in capital into the short end of the curve. Meanwhile, many other G10 central banks would continue to struggle to begin tightening, while those that might hike would do so very slowly."

Changes in interest rates, or hints of them being in the cards, are only made in response to movements in inflation but impact currencies because of the push and pull influence they have on international capital flows and their allure for short-term speculators.

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Reason for the Fed to Stick to its Path

Much has been said about the why the U.S. economic cycle is close to a turn for the worse and how the Federal Reserve will soon have to stop raising interest rates, or perhaps even cut them as growth slows and inflation falls. But Bloom says these views overlook a lot of what happened in the market during the last year, as well as what is happening now. 

"The Fed has delivered on the dots again so far in 2018 and even nudged the median dots higher. Yet the market is once again fighting the Fed," says Bloom. "Expectations for US GDP growth are still being revised higher and the recent renewed push higher in the ISM readings for manufacturing and services should provide further reassurance about the pace of economic growth. The ongoing push higher in wage growth is further reason for the Fed to stick to its path." 

Last year currency markets were sceptical the Fed would deliver on its "dot plot" hint for that year that interest rates would rise to 1.5% before the middle of 2018, but the top end of the current Federal Funds rate now sits at 2% so the central bank has over-delivered. December 2017's dot plot suggests rates will rise to 2.25% before January 2020, but rates are already close to this level and the U.S. economy continues to boom, while inflation pressures are mounting.

Bloom and the HSBC team say the U.S. Dollar's current valuation is "not especially rich" and investor positioning, which refers to the amount of money stacked behind the Dollar, is not yet problematic. To them, this means the Dollar can continue to grind higher if the Federal Reserve and its international counterparts continue to head in opposing directions.

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King Dollar is Dominant in a Downturn

The Dollar index was 2.4% higher for 2018, at 94.55 Tuesday. Meanwhile, the Pound and Euro were nursing 2.5% losses against the greenback while the risk-sensitive Australian and New Zealand Dollars are sat on declines of 7.6% and 6.9% respectively.

Those latter Antipodes-centred performances go some way toward illustrating how the greenback would benefit under HSBC's second bullish scenario for the year ahead.

"There are many routes to a downturn," says Bloom. "History suggests that synchronised global upswings that are accompanied by greater than expected Fed tightening (which has been the case in 2017 and H1 2018) have been followed by crises elsewhere (see The Return of the Monkey’s Paw by Stephen King, 7 August 2018). Or perhaps the world will succumb to event risks such as spiralling descent into a tit-for-tat global trade war."

As the world's reserve currency, the Dollar acts like a safe-have during times of tension or crisis. It has been boosted against the commodity and China-exposed Australian and New Zealand Dollars in recent months, given those latter currencies would be among the first to suffer if President Donald Trump's trade war with China were to damage the world's second largest economy. 

Whether or not the trade war leads to a crisis, or investors simply become uneasy because global growth slows again once into 2019, there is ample scope for risk-averse behaviour to dominate markets during the year ahead. And this would also benefit the U.S. Dollar.

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Fed Rethink May Not be Enough to Stop the Dollar

The only likely scenario envisaged by HSBC for 2019 in which the greenback does not benefit is one where the Federal Reserve either pauses its interest rate hiking cycle, or signals an end to it.

However, this is also the least likely according to Bloom, because events would have to successfully tread a very fine line between a Federal Reserve retreat that damages the Dollar and one that merely serves to spur it even higher. 

"The Fed’s earlier end to its tightening cycle would presumably be a function of economic data which suggested enough had been done on the policy front. However, that initially reassuring goldilocks data, an equilibrium state of not too hot/not too cold, might simply have been a transition towards something more sinister," says Bloom. "We believe any such deterioration would lead to a risk-off scenario and be USD bullish."

Typically, if a central bank took the decision to stop raising interest rates it would be because either inflation itself or expectations of future inflation had fallen to such a degree that tighter monetary policy is no longer required to keep consumer price growth close to its relevant target. 

However, an inflation outlook that evolves in such a way is most frequently the result of a deterioration of in the broader economic outlook. Given that global growth has already wobbled in 2018, with the U.S. economy being in a stimulus-backed league of its own, signs of a slowdown would be likely to stoke fears for other economies and currencies elsewhere.

Bloom and the HSBC team forecast the Dollar will remain on the front foot through the rest of 2018 and at least until the end of 2019. They project the Pound-to-Dollar rate will decline to 1.30 before year-end and remain close to that level through 2019 while the Euro-to-Dollar rate is expected to decline to 1.13 by December before dropping to 1.10 in 2019.

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