By Hussein Sayed Chief Market Strategist at FXTM
By Hussein Sayed Chief Market Strategist at FXTM

Is the Greenback’s rally sustainable?

The U.S. Dollar’s exchange rate has attracted a lot of attention throughout the past several months, especially against EM currencies which many of them fell to record or multi years lows.  Argentine peso held the title of the worst performing currency in 2018, having lost more than half its value since the beginning of the year.

First Published: e-Forex Magazine 82 / Currency Clips / September 2018

The U.S. Dollar’s exchange rate has attracted a lot of attention throughout the past several months, especially against EM currencies which many of them fell to record or multi years lows.  Argentine peso held the title of the worst performing currency in 2018, having lost more than half its value since the beginning of the year. The Turkish lira comes second, with more than 40% erased from its value. While the South African Rand, Indian Rupee, and Russian Ruble fell less significantly, they still lost 20% so far. 

One may argue that many of these economies face one or combination of huge current account deficits, external imbalances, shortages in FX reserves, and political risks that are leading to the selling wave. However, the Dollar has appreciated against all major currencies after dropping 2% in the second half of August. So, are we heading towards another bull run?  In the short-run, it seems the odds remain in favor of a higher Dollar. The key drivers are economic data, the Fed, and trade tensions. 

The most recent ISM data showed manufacturing and service sectors activity grew faster than most optimistic economists’ predictions. Job growth remains robust, but more importantly, wage growth hit a nine-year high in August. The upcoming data may also show solid performance for retail sales and consumer inflation. This should further boost expectations for two more rate hikes in 2018, leading to further divergence in monetary policies.  The greenback became the destination for safe-haven flows amid the escalation of trade tensions. That’s not because trade war is good to the U.S., but it’s simply because it’s worse for its trading partners. Given that the U.S. economy is at full employment, import tariffs will likely push inflation higher, and thus more interest rate hikes. 

Longer term the Dollar likely to face many headwinds. A full-blown trade war will start dragging companies’ earnings, especially that growth in the U.S. seems to have peaked. Chances of the Federal Reserve pausing the tightening cycle in 2019 are looking very high especially that external risks are growing. The ongoing trade dispute doesn’t seem to be helping to narrow the current account deficit. According to latest figures, the U.S.  trade deficit hit a five-month high, with China’s trade surplus against the U.S. widening to a record $31 billion in August. While higher U.S. interest rates and expected return on investments may continue to attract foreign capital in the shorter run, the long run doesn’t seem to be very bright. So, except the greenback’s rally to start fading as we approach the end of 2018.