Dollar set to feel the squeeze against euro
At the start of the year, we took the view that while the US dollar was in long-term decline, it would likely enjoy periods of strength during 2018.
The basis of this view was that the extreme short positions built up against the US currency in foreign exchange markets could well unwind, while President Trump’s cuts in US corporate taxes were likely to trigger dollar inflows as funds were repatriated by large corporates to the US.
The euro rose to a high of $1.25 early in the year, before the dollar started to rally, making significant gains in the past two months. As well as the above factors, the dollar was aided by strong US data. The euro has found support at around the $1.16 level in the past week.
We are still of the view that the US dollar will weaken over the longer term. A number of factors drive this assessment. We are concerned about the policy mix in the US.
The expansionary fiscal policy will lead to a sharp jump in the US budget deficit. It will also put upward pressure on the US balance of payments deficit.
These factors point to a lower dollar.
We are also concerned that the US economy could slow sharply once the fiscal stimulus fades.
Finally, the dollar is now at quite elevated levels against a range of currencies, pointing to downside potential.
The relative strength of the US economy, widening interest rate differentials, stresses in some emerging markets and, indeed, in some peripheral eurozone markets too, are all supportive of the US currency.
However, even if the dollar continues to rise against emerging markets currencies, further gains against the euro may prove difficult.
The euro is already showing signs of stabilising on expectations that the ECB will soon signal that it will end net asset purchases under its QE programme by the end of the year.
Overall, we think that the major move upwards by the dollar against the euro during the last couple of months is largely over.
We would expect the euro/dollar rate to now stabilise and trade in a $1.16-$1.20 range over the summer.
It should rise above the $1.20 level later in the year as the ECB brings net asset purchases to an end and concerns re-emerge about the US economy’s growth prospects over the medium term.
Oliver Mangan is chief economist at AIB
