Global Currencies 4Q19: Resilient dollar

The greenback is unlikely to give up its relative strength
Chief Investment Office04 Nov 2019
Photo credit: AFP Photo

The US dollar has been resilient to the two Fed cuts this year. Global trade tensions have kept the US economy and the greenback strong relative to the rest of the world. The Federal Reserve did not subscribe to US recession fears implied by the inverted US yield curve. The Fed considered its rate cuts in July and September to be a “mid-cycle adjustments” to global growth risks – especially trade war-related risks that weighed on the US economy. Until US data stop surprising on the upside and falter, and drag the major US stock indices sharply lower, the greenback is unlikely to give up its relative strength. We expect the USD Index (DXY) to keep grinding higher toward 100 for the rest of the year.

Multiple risks are threatening to push the euro lower into a 1.05-1.10 range. The Eurozone’s three largest economies – Germany, Italy, and the UK – are vulnerable to recession risks. Besides a more fragmented EU Parliament elected in May, the increased prospect of a disorderly Brexit, another re-escalation in the US-China trade war, and US trade aggression are looking to target Europe next. Germany is putting together contingent stimulus measures for a possible recession. The ECB has lowered its deposit facility rate by 10 bps to -0.50% and is scheduled to resume its asset purchases programme in November. Christine Lagarde, who succeeds Mario Draghi as ECB President come end October, will inherit the dovish legacy of her predecessor.

A no-deal Brexit is not the only threat to a weaker British pound below 1.20. It is no longer an absolute certainty that political hurdles can overpower UK Prime Minister Boris Johnson’s determination to accept, if necessary, a no-deal Brexit on 31 October. A hard Brexit is seen tipping the UK economy into recession and leading to debt rating downgrades and interest rate cuts. The BOE reckoned that even if the UK exits the EU with a deal, there will be a one-in-three chance for a UK recession. Real GDP growth has, for the first time since 2012, contracted by 0.2% q/q in 2Q19. Historically, GBP has not been known to dodge a selloff from recession or UK-specific event risks.

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