USD: A moderation in Fed’s policy and risk appetite should weaken the dollar in 2019 - NBF

According to analysts at National Bank of Canada, after registering solid gains 2018, the US dollar is set for a giveback, on the back of a moderation in the pace of monetary policy tightening by the Federal Reserve coupled with the return of risk-taking. They see that for USD weakness to be sustained, trade tensions between the US and major trade partners will have to subside.

Key Quotes:

“The trade-weighted U.S. dollar is within a hair of surpassing its all-time high reached back in January 2002. While diverging monetary policies, driven by the U.S. economy’s outperformance of other OECD economies, are fueling the greenback’s ascent, they do not entirely explain the USD’s surge. The trade-weighted USD is now more than 20% higher than it was back in 2007 even though the U.S. yield advantage is similar to what it was 11 years ago.”

“The return of risk aversion in financial markets has clearly helped the USD, particularly in recent months. But because the greenback has outperformed other “safe haven” currencies such as the yen and swiss franc this year, there must be something else at play. And here we’re thinking of speculators who have taken net long “noncommercial” positions on the USD to the highest in a year and a half. In other words, while the USD is now flying high, don’t rule out a sharp correction in 2019, amplified by the reversal of those net long positions. What could trigger such a reversal? The return of appetite for risk in global financial markets would do just that. Another possible trigger is a change of stance by a currently hawkish Federal Reserve.

“We suspect the fed funds rate, and hence the USD, are not far from peaking.”