US Dollar Outlook Lacks Spirit

Greenback is set to remain under pressure

Currency traders may have a dull year in 2018, with the US dollar seeing sluggish movement. Optimists anticipate that rate hikes by the Federal Reserve will buoy the currency. That information, however, appears to have already been digested by the market. And developments surrounding the Trump administration are likely to cast a pall over any latent demand for the greenback.

Many currency specialists missed the downside in the US dollar last year. Indices that measure activity against the major currencies saw a decline of about 10% in 2017, delivering the worst annual return since 2003. One key reason is that attention shifted to Europe, where domestic demand led to unanticipated strong activity. According to the IMF, real GDP estimates for the European Union will moderate from 2.4% in 2017 to 2.1% in 2018, but there may continue to be healthy growth revisions.

The relatively weak US dollar is good news for equity investors. US corporates will continue to benefit from ongoing pricing power in global markets. That benefit will be mirrored in those emerging markets where currencies closely track the US dollar, such as those in Asia.

We do not see an impact on bond markets over the year ahead. US inflation remains persistently low because of globalization; currency weakness will not change that reality. Most interest-rate pundits expect the Federal Reserve to roll out tighter policy in a predictable manner, although there is lingering debate on the number of rate increases to be seen in 2018.

We are puzzled by the argument that US tax reform will drive currency strength. Some cash will make its way back to America, as US corporates consider the benefits of earnings repatriation. The tax on overseas income is now reduced from 35% to 15.5%. But most of that offshore capital is already banked in US dollars. At best, the repatriation argument could impact economic growth, leading to more enthusiasm for domestic opportunities, but the tax measure is not a tax holiday. Repatriation moves are likely to be drawn out over time.

The medium-term outlook for the US dollar is even more murky. The currency may turn volatile over a two-to-four year span as investors fret over federal borrowing and political vagary. Those issues may drive foreign investors exposed to US assets to liquidate their historically-high positions.

Perhaps the most interesting aspect of US dollar analysis right now is academic. Can Bitcoin and other cryptocurrencies take the shine off the currency as a reserve unit? While it is easy to discount moves in these assets as faddish, we look beyond now-thin activity to see if a larger trend evolves. Momentum could be driven by a greater willingness in the developing world to use cryptocurrencies as a replacement for national fiat currencies.

Our Vantage Point: Those searching for prominent investment ideals should look beyond the US dollar, at least over the year ahead. Aside from a meltdown in Washington politics, there appear to be few currency-market surprises on the horizon.

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Image: US corporates will continue to benefit from the weak dollar. Credit: Feverpitched at Can Stock Photo Inc.