After its worst performance in 14 years, it would make sense that the beaten-down dollar should rebound next year, especially with the Fed raising interest rates and an oncoming gusher of fiscal stimulus from tax cuts.
But some strategists instead see the dollar
continuing its decline, which started in the early days of 2017, as it
competes with other currencies in a period of synchronized global
"We have a negative bias on the dollar, which is
extraordinary considering that interest rates are going to rise at a
very good clip," said Jens Nordvig, CEO of Exante Data. "It got too
strong before January, and the other factor is that global growth is
President Donald Trump favors a weaker dollar and he
has said as much, comments that added to negative sentiment on the
greenback early in the year, according to Nordvig. U.S. exports are much
more competitive in a world with a weaker dollar.
"I think for
next year, the big question is, is this tax reform going to be able to
provide any support or not?" Nordvig said. Corporate taxes were cut to
21 percent from 35 percent, and individual rates were also sliced for
What could change the course for the dollar is if
the Federal Reserve ratchets up its forecast for interest rate
increases. The central bank currently expects to hike three times, but
some Wall Street economists are now expecting four because of the tax
cuts and improved growth. They say the Fed could revise its forecast
after its March meeting.
"If they at some time start to think that
is not enough, that would be a very hawkish signal that would take the
dollar up. The problem is even if we have this good news, and people are
getting excited about tax reform, inflation is not there," he said. "If
inflation numbers don't come through in coming months, it's not a slam
dunk they hike in March."
Citigroup currency strategists said they
were also expecting a negative move in the U.S. dollar next year, and
they forecast a 5 percent decline against developed country currencies
in the next six months to a year, but less against emerging markets.
Citi strategists said drivers for the dollar are the fact that global
growth is now converging in the U.S., Europe, Japan and emerging
markets, instead of diverging. They also see more upside for the euro as
the European Central Bank continues to be more accomodative than the
Federal Reserve, and they note a longer-term trend of deterioration in
the U.S. net international asset position over the past 10 years.
dollar index, which represents a basket of currencies dominated by the
euro, has dropped 9.9 percent this year, its worst performance since
2003. The euro, trading at $1.20, has gained about 14 percent for the
year — its best performance in 14 years.
"The euro zone is growing
at the same pace," Nordvig said. "Clearly, the euro got to a very low
level, and it's recovering, and I think there's a lot of people who have
been surprised by this euro strength. So they're in the process of
getting back to benchmark and changing their hedges."
big investors, like insurance companies, are unwinding long dollar
positions they added in 2014, when Europe and other sovereigns were
going to negative rates. That unwind continues, but it could be coming
nearer to an end, he said.
But Robert Sinche, chief global
strategist at Amherst Pierpont, said he expects the dollar to reverse
course and gain 5 to 8 percent against a group of currencies in 2018. He
writes off some of the recent decline to seasonal weakness at this time
of year, based on reduced capital flows.
"The euro was up 14.1
pct since the end of last year. Over a five-year period, the euro is
down 9 percent. It's kind of like, 'is the dollar strong? or is the
dollar weak?' It depends where you start," he said. Sinche said he
expects higher rates to be a catalyst for the dollar, and he expects to
see global bond yields rise.
"People who are complacent on the
bond market are forgetting about that by October, the ECB is out of the
asset purchase business. The Fed balance sheet reduction accelerates
each quarter and becomes meaningful by the end of the next year," he
said. "I think we could have a much different supply demand backdrop by
the end of 2018, and I think one of the surprises will be that bond
yields around the world will move up more than people think."
investors have been watching for an impact on the dollar from U.S.
companies repatriating billions in overseas profits, which is required
by the tax law changes that take affect Jan. 1. But Nordvig said his
firm found it will not have a major influence.
The dollar could be
hurt by capital flows into Europe or China. Nordvig said he expects to
see continued flows into China as investors move into Chinese markets.
"These markets that had been closed to foreigners have been opened up,"
he said. "They are picking up and that's something that has more
potential to be something in 2018. The Chinese officials recognize this.
They want them to open up."
Another risk for the dollar is the
potential for a trade skirmish between the U.S. and other countries.
Nordvig said he sees a 50 percent chance that NAFTA talks fail. He said
it's possible the U.S. could also have a trade dispute with other
If NAFTA falls apart, "The country that's going to be
hurt is Mexico, but I don't think it's going to help the United States,
so it could strengthen the euro and it could strengthen the yen," he
said. "Europe just did a trade deal with Japan in record time. Europe is
going to do a free trade agreement with Brazil. They're going to do one
with Mexico as well. ... It could be the strengthening of the other
kind of reserve currencies — the euro and the yen."