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|13 December, 2018

Are dollar bulls running out of inspiration?

Lukman Otunuga is a research analyst at FXTM. A keen follower of macroeconomic events, with a strong professional and academic background in finance, Lukman is well versed in the various factors affecting the currency and commodity markets. Lukman holds a BSc (hons) degree in Economics from the University of Essex, UK and an MSc in Finance from London School of Business and Finance, where he studied corporate finance, mergers & acquisitions and the role of international financial institutions.

Website: www.forextime.com

The greenback's strength should not be taken for granted as Fed comments create uncertainty over future rate hikes

Widening interest rate differentials between the Federal Reserve and major central banks across the globe ensured Dollar strength was a major market theme this year.

Confidence over the strength of the US economy magnetised investors towards the dollar in times of caution and uncertainty. With the greenback heavily supported by the prospects of higher US interest rates and safe-haven demand in times of uncertainty, the currency reigned supreme across FX markets. But dovish comments from Fed officials and disappointing economic data in recent weeks have clouded the Dollar’s outlook beyond this year. With investors now re-evaluating the Federal Reserve’s hiking path, Dollar bulls remain at threat of running out of inspiration.

External risks in the form of plateauing global growth, geopolitical risk factors and ongoing trade tensions are seen impacting the US policy outlook in the medium to longer term. Domestically, the effects of higher US interest rates are already weighing on some parts of the US economy, including the housing market. With US President Donald Trump’s repeated criticism of the Federal Reserve complicating matters, it may be increasingly difficult for the dollar to push higher. Recent comments from an IMF Chief economist that the US economy will face a sharp slowdown in 2020 is likely to add to the growing gloom.

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November’s disappointing US jobs report certainly addresses recent concerns over the US economy facing some headwinds, given the inversion of the US Treasury yield curve in early December. With a chorus of Fed officials, including chairman Jerome Powell adopting a dovish stance, the sentiment pendulum towards the Dollar is seen moving in favour of the bears. It must be kept in mind that Powell also mentioned that past interest rate increases have a lagged effect, meaning that this year’s tightening has yet to be fully felt on the US economy. Based on this point, the Federal Reserve has a valid excuse to pause on tightening monetary policy to prevent a situation where consistent rate hikes threaten economic growth.

In regards to the technical picture, it has been an incredibly bullish year for the greenback with the Dollar Index hitting a yearly peak at 97.69. Although safe-haven flows could encourage the dollar index to test 98.00, headwinds in the form of fading Fed hike expectations are seen obstructing upside gains. If bulls run out of steam with prices securing a yearly close below 95.00, Dollar bears are likely to start next year hitting the ground running.

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