Traders See No End to the Dollar’s Pain in 2018

Updated on
  • ECB, BOJ seen as catalysts for $5.1-trillion-a-day FX market
  • Greenback’s drop this year is set to be worst in over a decade
Bryan Goh, Singapore chief investment officer at Bordier & Cie, discusses the dollar and his outlook for Fed policy.

For the almighty dollar, 2017 has been nothing short of abysmal. Next year might be even worse.

Despite a recent bounce back, analysts and investors say the greenback could lose more ground against the euro and yen as the prospect of strong economic growth and tighter monetary policy outside the U.S. more than offsets higher interest rates at home. The dollar is down more than 7 percent versus the world’s major currencies this year, the most in over a decade.

The economic growth “we’re seeing in Europe, emerging markets and the rest of the world will likely cause the dollar to sell off again,” said Erin Browne, the head of asset allocation at UBS Asset Management, which oversees about $770 billion. When it comes to what central banks in Europe and Japan might do, “there’s very little priced in.”

Browne says the euro could reach $1.30 in 2018, representing a 10.2 percent advance against the dollar. That would be on top of a rally of about 12 percent this year. She also expects further gains in the yen. The dollar was at $1.1790 per euro and 112.85 yen.

It wasn’t supposed to turn out like this. At the start of the year, strategists were almost uniformly bullish on the dollar as traders embraced President Donald Trump’s election and his pro-growth promises of lower taxes and higher infrastructure spending. The Federal Reserve was also set to raise rates, providing more support for the currency.

Yet, much of that optimism soon unraveled. Yes, the Fed has raised rates three times, but the rally never materialized as lackluster inflation and pessimism over the ability of Trump and his fellow Republicans to make good on their legislative promises took their toll.

Currency traders sold dollars this year despite a surge in forward interest-rate swaps, which essentially reflects a bet on more tightening by the Fed. Instead, they bought euros and yen.

Now, many see the Fed closer to the end of its tightening cycle, which has the $5.1 trillion-a-day foreign-exchange market more focused on the European Central Bank and the Bank of Japan. The shift comes as global growth is expected to strengthen to 3.7 percent next year, the most in seven years.

For the euro, any sign of an economic pickup that prompts the ECB to wind down its bond-buying stimulus could fuel further gains against the dollar.

‘Substantially Weaker’

“Most of the people that we talk to wouldn’t be terribly surprised if, by the end of next year, the dollar was substantially weaker,” especially against the euro, said Daniel Katzive, head of FX strategy in North America at BNP Paribas.

It’s not just talk. In the futures market, hedge funds and money managers have piled into bullish bets on the euro, pushing them close to a six-year high on a net basis.

Speculators are less convinced about the yen, but to Deutsche Bank’s Alan Ruskin, that just means there’s greater potential for a bigger move if the BOJ does retreat from its policy of targeting bond-yield levels. The yen has weakened since the measure, which acts as a form of monetary easing, was introduced in September 2016.

“The yen is actually extremely cheap, so when it turns, it could turn fairly sharply,” said Ruskin, the firm’s global co-head of foreign-exchange research.

Of course, even dollar bears acknowledge there’s a good chance that Trump’s tax cuts could give the greenback a fillip in the first half of the new year. But few see it lasting into the second half -- even if the Fed keeps raising rates. Analysts see the greenback losing ground to 13 of the world’s 16 most-widely traded currencies through the end of next year.

“The Fed can be hawkish and hike, and hike, and hike -- and the dollar goes up a little bit,” said BNP’s Katzive. With all eyes on the ECB and BOJ, “dollar vulnerability versus currencies is always there, and the minute you push the needle a little bit in one direction, you could see an outsized reaction.”

— With assistance by Chikafumi Hodo, and Jacob Bourne

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