A hawkish Federal Reserve, an economy firing on all cylinders, the tentative revival of the “Trump Trade” — all that won’t be enough to boost the dollar next year, according to a chorus of Wall Street strategists.
The dollar is heading for its worst year in more than a decade, and bearish projections are still piling up. Analysts say the steady unraveling of the greenback’s post-crisis bull run will be confirmed next year as global growth gathers pace and central banks converge on a more hawkish tone.
“Beware of sleeping volcanoes and seriously undervalued currencies,” Kit Juckes, global fixed-income strategist at Societe Generale SA, wrote in a report Tuesday. With global “growth becoming more balanced and more synchronized, the dollar looks expensive.”
Traditional valuation models are set to stage a tentative recovery as central banks become more tolerant of currency appreciation, while yields in overseas markets rise, according to analysts.
“We think 2017 was a watershed year for the dollar,” said Ned Rumpeltin, currency strategist at TD Securities Inc. “As long as global growth maintains a steady pace, reflationary tailwinds persist, and U.S. inflation does not unexpectedly — and uniquely — surge, the global macro landscape should favor a steady depreciation of the dollar.”
Case in point: The dollar’s underwhelming reaction to legislative progress on U.S. tax reform, which was seen as the linchpin for reflation after Trump was elected.
For greenback bears, the reasoning is simple. The tax plan is unlikely to spark a sudden surge of repatriation, while stronger global growth spurs higher yields overseas and the euro-zone recovery gains more traction.
Nominal effective exchange rates suggest the dollar looks rich relative to peers in trade-weighted terms.
“Bringing the money back will merely involve an ‘accounting’ shift rather than a withdrawal of offshore dollar liquidity,” George Saravelos, head of foreign-exchange research at Deutsche Bank AG, wrote in a note.
While the first half of next year may deliver more of the same, the dollar will likely be under even more pressure in the second half of next year as interest-rate markets price in less monetary stimulus from the European Central Bank, analysts said.
The Federal Reserve would likely need to deliver a hawkish shock accompanied by much higher real yields to give dollar bulls hope.
While the U.S. Dollar Index has tumbled 8.6 percent this year, it remains 25 percent above its 2011 low, and, in real terms, the exchange rate is 5 percent above its 20-year average, according to Societe Generale.
What’s the line in the sand to watch for? The yield on 10-year Treasury Inflation-Protected Securities doubling to 1 percent, according to Juckes. Even a one percentage-point increase in the federal funds rate is unlikely to juice the U.S. currency given the improving foreign-exchange fundamentals overseas, he said.
Strategists at TD Securities are more bearish, casting the dollar as the most overvalued currency in the Group of 10 nations. Amid synchronized global output, only a financial shock is likely to rally the greenback, according to TD Securities.
The bank recommends long positions in an equal-weighted basket of the euro, Swedish krona and New Zealand dollar versus the U.S. currency and the Swiss franc.
Societe Generale projects the benchmark U.S. dollar index will drop 4.5 percent by the end of 2018, and is bullish the euro, Australian dollar, the Norwegian krone and a slew of eastern European currencies against the dollar.
“The main theme for major currencies in 2018 will be how long the dollar can continue to trade at historically strong levels following its long bull run since 2011,” Mansoor Mohi-uddin, head of currency strategy at NatWest Markets, wrote in a note last month.