FX Monthly Outlook: Another Day, Another Dollar

A strong U.S. dollar remains the ongoing theme as we settle into the third quarter of 2018. The greenback is trading near its year-to-date high against most currencies, including those of emerging markets. The economic trends are supportive, and the Fed remains steady and resolute. However, politics and trade headlines continue to put investors and traders on guard.

What's in Play?

Trade talks stall. The U.S. and China are trying to restart talks aimed at avoiding an intense trade war. Negotiations have been at a standstill for a few weeks as both parties lobbed threats and accusations of unfair play. Additional tariffs and the ongoing tension will keep markets in a cautious position.

The renminbi has taken a dive since April, and trade headlines have exacerbated the currency decline. The CNY is down almost 4.5 percent for the year, after being up 3.0 percent in the first quarter.

Compression continues in Treasury yields. The spread between 2-year and 10-year Treasury notes continues to narrow with each successive rate hike. The short end of the curve has steadily moved higher each quarter, while the longer maturities have remained relatively stable. This has stirred more conversations about an inverted yield curve and the potential of a pending recession.

The Federal Reserve has more or less avoided the topic. The central bank can move short-end rates much more effectively than longer-end rates. But so far, the debate has been more academic than market practice.

What's Next?

FOMC holds for now. The Federal Open Market Committee kept rates unchanged on August 1, but their statement leaves a “strong” possibility for a rate hike in September. It was a unanimous vote supported by comments about a solid labor market, rising inflation, and robust economic growth.

The probability of a rate hike in September is more than 90 percent, and the probability of another hike in December is about 65 percent. That bodes well for the dollar throughout the rest of 2018.

BOE makes a move. The Bank of England raised its benchmark rate for only the second time in nearly a decade to 0.75 percent. Most market participants expect this to be the only move for the year, and the pound continues to trend lower on prevailing dovish sentiment.

The pound is down 3.5 percent for the year despite decent economic metrics. Much of the downward pressure stems from the ongoing Brexit debates. Recent resignations by key cabinet members are creating greater uncertainties about how well negotiations with the European Union will go.

BOJ keeps rates low. The Bank of Japan pledged to keep interest rates low “for an extended period” and dispelled any speculation about an early exit or rate hike. The central bank noted that it will continue to intercede to keep 10-year yields low. Markets reacted quickly and pushed the Japanese 10-year down to 0.05 percent from 0.12 percent before the announcement.

What Happened?

The economy goes full throttle. The U.S. economy grew at 4.1 percent in the second quarter, the fastest pace since 2014. The expansion was fueled by consumer and business demand, export gains and a boost from tax cuts. Household consumption rebounded to 4.0 percent after a lackluster 0.50 percent the previous quarter.

The data certainly allows the FOMC to keep raising rates as the economy continues to absorb the gradual hikes without losing pace. That’s a bullish sign for the U.S. dollar.

Facebook un-liked! Facebook shares tumbled 20 percent after its earnings release stating that revenue growth would decline in the third and fourth quarter. The drop shaved off $120 billion in market cap. The social media giant has been plagued by Europe’s strict data laws and its involvement in the 2016 U.S. presidential election.

Up, up and away. U.S. corporate earnings for the first half of 2018 have been solid overall despite some big misses and constant volatility. However, investors remain optimistic, especially in the tech sector. The Nasdaq is now up 13.0 percent year-to-date, with the S&P at 5.8 percent. 

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Currency Spot Returns Table -- July 2018

Source: Bloomberg July 2018


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About the Author

Minh Trang is a senior foreign exchange trader. In his previous position at SVB, he worked as a portfolio manager for SVB Asset Management, and has over twelve years of investment experience in fixed income securities. Prior to joining SVB Asset Management, Trang worked on the commercial paper sales and trading desk at Toyota, managing the western region. His experience also includes portfolio management at the Arizona State Treasury, focusing on the state's short-term fixed income investment pools. He started his career as a research analyst for PICO Holdings, a strategic investment company.

Trang earned his Masters in Business Administration at the University of California, Irvine and a bachelor in economics at the University of California, San Diego. He holds the Chartered Financial Analyst (CFA) designation and FINRA securities licenses 7 and 66.