Since we seem to spend quite a lot of time pointing out how often the year-end forecasts of respected judges prove to be wide of the mark, one might wonder why we spend so much time looking at them. It's not because we've become so jaundiced that we automatically like to take the contrarian view (we don't, necessarily). It's partly because the arguments put forward are generally coherent and worth considering even if the conclusions turn out to be wrong. And it's partly because it's extremely healthy for any trader to be reminded how the markets can make fools of even the best and the brightest. Nobody really KNOWS anything, remember ?
The consensus view -- by definition, a broad generalisation and apologies to successful minority players -- at the start of both 2016 and 2017 was firmly in the camp of a stronger dollar. In the second half of 2016 the dollar did of course stage a strong rally (especially after Trump's election win), but such was its weakness for the first five months of the year that it's highly unlikely that many of the dollar-bull strategies adopted at the start of the year were still in play. In 2017, despite all the Trump-related bullishness regarding stimulus, growth and interest rates, the dollar was on a largely uninterrupted slide until September.
It's a bit early to say what the consensus will be this year-end. Opinion may be more equally divided than normal at this stage, but after the dollar's worst year in over a decade there's certainly no shortage of dollar bears to be found. It's all a matter of interpretation, of course. It's not as though there aren't factors that COULD be construed as quintessentially dollar-friendly : a hawkish Federal Reserve, a strong economy with low unemployment and attendant inflationary risks, a revival of the Trump Trade excitement that we saw at the end of 2016.
But according to a bunch of high-profile traders interviewed by Bloomberg, and who are looking more and more like they'll represent the consensus view, none of the above will be enough to boost the US currency. For example, Societe Generale are of the view that as global growth becomes more balanced and synchronised, the dollar looks more expensive. As overseas economies strengthen and yields rise accordingly, central banks will become more tolerant of currency appreciation.
TD Securities have thrown in a few provisos but ultimately offer another poor outlook for the dollar : "As long as global growth maintains a steady pace, reflationary tailwinds persist, and US inflation does not unexpectedly -- and uniquely -- surge, the global macro landscape should favour a steady depreciation of the dollar".
An example of how the underlying sentiment towards the dollar has changed can be seen in the almost total LACK of reaction on foreign exchanges to the progress being made on US tax reform. After the election last year, tax reform was seen as a linchpin for the whole "Trumpflation" phenomenon. Now we're finally getting close to signing off on tax reform, the issue seems to have become a bit ..... well, "ho-hum".
In part, that might be because there's some doubt about how effective the measures will be, particularly with regard to large-scale repatriation of funds by US companies. Deutsche Bank argue that such a development is unlikely :"Bringing the money back will merely involve an accounting shift rather than a withdrawal of offshore dollar liquidity".
If you accept that there'll be little boost for the dollar from the repatriation angle, and set it against stronger global growth generally inducing higher yields overseas, you've got yourself a bearish dollar story. As far as EUR / USD is concerned, euro strength should be even more marked later in 2018 as markets price in the withdrawal of stimulus from the European Central Bank.
Fair enough, but hasn't the dollar already fallen a long way this year ? Yes, that's true ..... the Dollar Index has fallen 8.6%, in fact. But it's still 25% ABOVE the low set in 2011 before it embarked on its long bull run. According to Soc Gen, in real terms the dollar exchange rate is 5% above its 20-year average.
So what might change the dollar's poor prognosis for 2018 ? One of the most fundamental of all foreign exchange factors is comparative interest rates, but so far the Fed's repeated hikes to short-term rates have been of little or no help to the dollar. Even if the Fed continues on that course, the improving fundamentals overseas mean that there is no reason to believe Fed hikes will boost the currency. What might do it however is a rise in longer-term yields, and for that to happen we're going to need a spike in inflation (and inflation expectations).
Since the absence of inflationary pressure is something of a mystery the world over, one could never be confident in any sudden reappearance. But many experts still agree that it must assert itself sooner or later, and if and when it does, given the very low levels of unemployment it's likely to do so first in the US. Now that might upset the dollar bears .....