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.