- Our podcast explores why the dollar will remain bearish moving into 2019
- Our cynical view on the dollar stems from its multi-year downtrend in early 2017, which continued into early 2018
- We view this as a temporary correction within the broader downtrend
Many factors have impacted the dollar’s correction - US growth divergence, the Fed’s resolve, the US repatriation theme, excessive dollar bearishness and the various bouts of risk aversion. But we do think that most of these forces are reversing or weakening, and importantly investors are bullish on the dollar into 2019.
In the year ahead, we expect a renewed focus on growing US current account and budget deficits, yields not being high enough to compensate for these risks, a reconvergence of US and rest-of-the-world growth and capital repatriation by other countries.
From a trading perspective, we think the early part of 2019 could see more pronounced dollar weakness against other high yielders, before later in 2019, when we could see more weakness against the G5 currencies as the broader risk environment worsens.
Reverting back to the 1990s carry trade heyday? (No!)
The nominal short-term interest rate gap between the USD and EUR or JPY is currently very wide. At almost 3%, the carry is the highest in over a decade and there may be high demand for such a return so we could easily see the return of the dollar carry trade, which could spur dollar gains. Many will cite the 1990s as the reference period for a similar theme but the details of that period suggest caution in drawing parallels.
The major period of dollar carry trades actually occurred during the second half of the 1990s. After the Fed raised rates in 1994 to above 5%, carry became a dominant investment strategy. It was most clearly manifested in USD/JPY, which rose from 84 in 1995 to 145 in 1998, before it collapsed as carry trades often do. The broader backdrop to this period, however, had three important differences to today.
- US asset markets were at the beginning of a boom in the mid-1990s.
- Both the Bank of Japan and the Bundesbank were easing policy and keeping rates low in the second-half of the 1990s, while the Fed was hiking and keeping rates high
- The US budget balance was improving for much of the 1990s, culminating in surpluses from 1998 onwards.
In a final look forward towards 2019 there are a couple of key points worth noting that will contribute towards the depreciation of the dollar. The US current account deficit is likely to widen as the effect of US export frontloading fades, while the tax cuts will contribute to an increase of the US budget deficit. This will lead to the deterioration of US twin deficits problem, but in 2019 this is unlikely to be balanced by the relative US growth outperformance.
Read the full report on the Dollar in 2019: Yield vs Deficits.
Head of Fixed Income Research, EMEA
FX Strategist, EMEA