Room for dollar and sterling recoveries to gain real momentum
The currency’s slide was surprising given that the Fed delivered three 25 basis point rate hikes in December, March and June, taking official rates in the US up to 1.125% by mid-year, well above rates for the other major currencies.
The dollar, though, has stabilised in the past couple of months as the Fed reaffirmed its commitment to continue hiking rates in a steady fashion and indicated that a further rate increase was likely before year end. The Trump Administration has also been attempting to make progress on its tax cut plans, which it wants to see implemented next year. US economic data have also remained solid, with the unemployment rate falling below 4.5%.
As a result, there has been a firming of market expectations in regard to US rates in the past two months. Markets now see the next US rate hike occurring at the end of 2017 compared to the end of 2018 previously, while they also expect US rates to rise to 1.875% by the end of 2019 compared to 1.5% a couple of months back. However, this is still some way below the Fed’s projection of 2.75% for the funds rate at the end of 2019.
While the dollar has stabilised, the market seems reluctant to push it higher. One reason is that it could be well into next year before it becomes clear whether or not the market is underestimating the extent of Fed rate tightening. In addition, progress is likely to be slow on getting Trump’s tax cutting agenda implemented.
Thus, there is still considerable uncertainty about the outlook for US monetary and fiscal policy. Hence, the dollar could well remain range bound over the rest of the year, trading in a $1.16-$1.20 band against the euro. It is worth noting that the euro started the year at around $1.05 against the US currency.
Turning to 2018, there could be some developments that favour the dollar. The US economy looks to have a good deal of momentum as we come towards the end of 2017. Thus, the Fed may well surprise markets with the extent of its policy tightening next year.
Meanwhile, some of Trump’s tax cut plans could be implemented ahead of mid-term congressional elections in 2018, which would add to the case for monetary tightening. Furthermore, there is still speculation about a possible large, one-off cut to the US corporate tax rate in an amnesty designed to entice back profits held by US corporates overseas. This should trigger dollar gains, as companies are likely to need to swap some funds into dollars to repatriate them.
Sterling is another currency that has had a difficult year, having already fallen sharply in 2016. However, it too has shown signs of stabilising in the past couple of months, helped by talk of a possible rate hike from the Bank of England by year end. The Brexit negotiations between the EU and UK, though, are likely to be the key factor influencing sterling in the year ahead. There are growing hopes that a soft Brexit can be agreed, with transition arrangements that allow for continuing free trade between the UK and EU post March 2019, until a full trade deal is negotiated. Sterling can recover ground if this is what materialises next year. Moves towards a hard Brexit, though, would put renewed downward pressure on the currency.
Oliver Mangan is chief economist at AIB
