Greenback weakness predicted

Continued from FP1

Despite following through with the hikes, and the major tax reforms passed in the U.S., the greenback has lost ground.

“Once past the third move in a tightening or easing phase, a central bank loses its ability to shock the market or even influence it in a major way,” said Greg Anderson, global head of FX strategy at BMO Capital Markets. “That is where the Fed is at now, so we don’t think whether the Fed hikes two, three or four times will matter much for the USD index.” If the U.S. tax plan was implemented with border adjustment taxes, the U.S. dollar would have likely seen a big rally. However, the reforms that were passed don’t appear to alter America’s relative competitiveness very much at all, and are unlikely to lead to widespread repatriation of foreign profits.

“It contains no carrot that entices the onshoring of overseas funds; firms will pay the tax whether they repatriate or not,” Anderson said.

If taxes and rate hikes turn out to be non-factors for 2018, that could leave the currency vulnerable to global growth and America’s deteriorating balance sheet.

The greenback typically declines in years of abovepotential global growth, as stronger economies drive up commodity prices, and in turn, commodity currencies. Strong global growth also makes investment in emerging economies more attractive, causing money to flee developed markets.

If the IMF is correct that global growth will climb to 3.7 per cent in 2018, that would be well above its 10-year average World GDP growth rate of 3.4 per cent, which is roughly where potential growth probably lies.

The U.S. dollar also faces another negative driver in that reversals in America’s twin deficits (current account and federal budget), typically precede turns in the U.S. dollar by one to two years.

“The U.S.’s twin deficit fundamental has been deteriorating for the past two years and is likely to deteriorate further in 2018 and beyond due in part to the tax cuts,” the strategist said.

Considering these factors, and the fact that U.S. dollar phases tend to last five to seven years, Anderson anticipates broad greenback weakness in 2018 — although at a slower pace than in 2017.

Continued strength from the global currency that performed best last year — the euro — could also hurt the dollar’s relative valuation.

While Italy’s general election in early March certainly poses the risk of some instability, once the dust settles, the euro should gain back its footing.

That’s because the ECB is due to announce its own taper of quantitative easing, followed by an altering of forward guidance on rates in June.

“Having extended QE until September 2018 and guided that policy rates will stay on hold until ‘well past’ that date, it is reasonable that markets do not price rate normalization until well into 2019,” said Bruce Kasman, chief global economist at J.P. Morgan. “However, the ECB is in for large positive surprises on its current forecast…”

The ECB is forecasting