In 2018, the USD started the year by falling by 4%. Afterwards, the dollar index started a major rally and YTD, it has risen by more than 5%. From its YTD low, the index has gained by more than 10%. There were a number of reasons why the index rose. First, the Federal Reserve continued to sound hawkish. As such, the bank raised rates by four times this year. This was the highest number of rate hikes than any other major central bank. Second, the US economy continued to power on, gaining by more than 3%. This was fueled by the tax reform and tax cut act. Third, the competing countries’ economies were not doing well. This was more so in the European Union. Fourth, the ongoing global trade conflict between the US and China led to many investors to come view the dollar as a safe haven currency. Therefore, with the dollar ending the year on the high, this article explains what will likely happen for the currency in the coming year.
First, there are high chances that the period of dollar strength will be coming to an end. This is because, in recent weeks, the Federal Reserve officials have sounded less hawkish. Addressing the economic club of New York, the Fed chair said that the interest rate hikes were nearing the neutral rate. This was an indication that the bank will likely start putting brakes on more rate hikes. In fact, in a recent report, Goldman Sachs analysts said that chances of another rate hike in March had dropped to below 50%. A few weeks ago, this rate hike was already baked in. The consensus estimate is that the Fed will have two or three hikes this year. This will be lower than the four hikes in each of the past two years.
As this happens, it is important to look at what the other central banks will do. The European Central Bank (ECB) has guided that it will have at least one rate hike in the coming year. If it does this, it will be the first rate hike since the economic crisis. The Bank of England has guided that more hikes will be coming in case of an orderly Brexit. In Japan, the bank has been silent on when it will hike. The same is true with the Reserve Bank of Australia (RBA) and Reserve Bank of New Zealand (RBNZ). There is a likelihood that these banks will either have a rate hike or announce a plan to hike in 2020. If all these happens, traders can expect the dollar strength to start slowing.
Another component of all this is the American economy. After growing by 4.2% in the second quarter, the economy rose by 3.5% in the third quarter. Data released recently point to a weaker economy in the fourth quarter. It is also expected to weaken slightly in the coming year. Therefore, with all this, it is likely that the dollar will weaken as investors move to search for yield elsewhere.
One thing that could support the dollar in the coming year is corporate earnings. In the past quarter, companies did very well. However, they issued weak guidance. In the coming year, if the earnings weaken, there are chances that they will lead to a weaker dollar.