By Lukman Otunuga Research Analyst at FXTM
By Lukman Otunuga Research Analyst at FXTM

Dollar bears enter 2019 in the driver’s seat

Widening interest rate differentials between the United States and other major economies ensured king Dollar reigned supreme in currency markets last year.

Widening interest rate differentials between the United States and other major economies ensured king Dollar reigned supreme in currency markets last year.

Optimism over the strength of the US economy sent investor rushing towards the Dollar in times of market caution. With the Greenback heavily supported by prospects of higher US interest rates and safe-have demand in times of uncertainty, Dollar strength was certainly a dominant market theme. However, the flattening of the yield curve witnessed in the past few weeks coupled with dovish comments from a chorus of Fed officials led to a sharp change of sentiment towards the Dollar as we entered 2019. 

Rising geopolitical risks, fears over plateauing global growth and ongoing trade development are seen impacting the US policy outlook in the medium to longer term. Domestically, fading fiscal stimulus, weakness in the housing markets and political uncertainty in Washington are likely to weigh on the US economic outlook. It must be kept in mind that the effects of higher US interest rates are already weighing on some parts of the economy while the Fed announced they will be “patient” and “flexible” towards raising rates. With Powell also mentioning that the past interest rate increases have a delayed effect, the impacts of last year’s aggressive tightening has yet to be fully felt on the US economy. Based on this point, the Federal Reserve has a compelling reason to pause on tightening monetary policy to prevent a situation where consistent rate hikes have negative impact on economic growth.

Speaking of growth, the Dollar’s safe-haven status will be threatened by signs of slowing domestic growth. Although December’s impressive US jobs report eased concerns over the US economy facing headwinds, the notable slowdown in manufacturing which dropped to a two-year low during the same month remains a sore spot that the Fed will be unable to ignore. With the Fed adopting a data dependent approach towards monetary policy normalization, repeated instances of disappointing domestic data will weigh heavily on prospects of higher rates. Shifts in monetary policy in other major economies, including Europe and possibly Japan remain factors that are likely to weigh on the Dollar this year.

In regards to the technical picture, it has been a rough start to the year for the Greenback with the Dollar Index hitting a three-month low at 95.03. Although safe-haven flows from geopolitical risk could encourage the Dollar Index to defend 95.00, expectations of a pause in rate hikes are seen fuelling downside losses. With bulls clearly running out of steam and bears back in the driver’s seat, the Dollar Index looks positioned for a rough and rocky decline downhill once a monthly close below 95.00 is achieved. The technical levels of interest to the downside will be 94.00, 92.20 and 90.00. For bulls to have any chance of jumping back into the game, prices need to trade back above 97.00.

Dollar bears enter 2019  in the driver’s seat