FX Monthly Outlook: USD Falls and Can't Get Back Up

Bearish sentiment on the U.S. dollar continues to dominate the FX market this year. The greenback had one of its worst starts to the year in history — with the dollar index (DXY) falling over three percent in January. The market has all but ignored solid economic data, a tightening Federal Reserve and continuity in monetary policy. Instead, the focus has been on trade wars, international growth and global tightening.

So, what market forces are keeping the battered USD down for the count?

What’s in Play?

Eurozone growth remains bright. Economic growth in the Euro region posted another solid quarter as fourth quarter GDP hit 2.7 percent year over year. This was a tad better than the 2.6 percent expansion in the U.S.1

ECB turns hawkish. The European Central Bank announced no rate changes, but noted that it expects inflation and growth to hit targets in the foreseeable future that would justify a gradual normalization of monetary policy. The EUR rallied on the statement.

The comments from ECB and the GDP data were certainly two factors that supported the EUR rally throughout January.

The yield curve steepens. The 10-year Treasury note bounced up almost 40 basis points in January to levels not seen since 2014. After three interest rate hikes last year, the market is expecting the next one in March.

Davos disaster? The greenback plummeted shortly after comments by U.S. Treasury Secretary Mnuchin that a weak dollar is good for U.S. trade. The DXY (dollar index) has retraced its steps back to December 2014 levels.2

The political cloud continues to hang over the U.S. dollar — and has probably become its greatest headwind.

What’s next?

SOTU scores. The State of the Union (SOTU) address was fairly well received by the public. Going forward, the focus turns from economics to more social issues like immigration. Trade talks will also remain in the spotlight — which will impact relations with Canada, China and Mexico.

Tax impact expected. There are high expectations that the recent tax reforms will generate a windfall for corporate America, boosting durable goods orders in the first half of 2018. This positive sentiment is driving assets prices higher — especially in equities.

Hawks gather over London. The Bank of England meets in February for a rate decision. The expectation is no change and keeping the benchmark at 0.50 percent. However, smoother Brexit headlines and steady economic growth are fueling the pound — and the currency is now trading at pre-Brexit levels.

Goldilocks, beware of the bear. In the new environment of great uncertainty, it may pay to be ready for large swings in the market. Currencies like EUR and GBP have had fantastic runs in recent months, but some changes in fundamentals could change its course quickly. A smooth Brexit is not a sure bet and Euro-zone growth remains driven by the big three economies. More importantly, the U.S. continues to perform above par. Given these dynamics, it may be prudent to revisit exposures in these currencies and be aware and prepared to act on both potential risks and opportunities.

What Happened

Bitcoin takes a tumble. After surpassing 15K earlier in January, the digital currency fell to below 10,000. All the buzz has hit a lull, and the hype — for the moment — is taking a breather.

The Fed hangs tight. The Federal Reserve kept the benchmark rate unchanged in its latest meeting — as Janet Yellen prepared to pass the reins to Jerome Powell. While the message has been a changing of the guard, the policy remains the same.3

Markets are anticipating a rate hike in March. This might provide a spark for the dollar as succession is completed in sync with monetary policy

Equities soar. U.S. stocks rallied throughout January on optimism over the favorable tax and regulatory environment. The Dow Jones rose 5.8 percent, the S&P was up 5.6 percent, and the NASDAQ climbed to 7.3 percent for the month. It’s one of the best starts in years for investors.

Canada stays on track. The Bank of Canada kept the benchmark rate at 1.25 percent for its first meeting of the year, citing no rush to pursue aggressive interest rate hikes. Bank officials have been trying to gradually bring rates back to more normal levels — without triggering an economic slowdown. Employment has been strong and GDP grew at 3.5 percent in the latest quarter.4

Currency Spot Returns Table -- January 2018  

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1 Bloomberg

2 The Wall Street Journal

3 The Wall Street Journal

4 Bloomberg


This article is intended for US audiences only.

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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.