US dollar closed 2018 up 4%; repeat unlikely in 2019

The dollar closed out 2018 at the top of the foreign exchange heap – a feat many investors don't expect it to repeat in 2019.

The WSJ Dollar Index, which measures the US currency's performance against a basket of 16 others, climbed 4.3% in 2018. The only other major currency to record a gain for the year was the Japanese yen, which rose more than 2%.

The US currency's rise has hurt the balance sheets of multinational companies that need to convert overseas earnings into dollars, while weighing on exporters by making their products less competitive abroad. Oil, gold, copper and other commodities have also felt the pressure of a stronger dollar: Most raw materials are priced in the US currency and cost more for foreign buyers when the dollar appreciates.

The dollar is in a position of continued strength for the new year. Futures bets on a higher US currency stand near their highest level since 2015, according to data from the Commodities Futures Trading Commission. A December survey by Bank of America Merrill Lynch said investors cited holding dollars as the market's most "crowded" trade, beating out big-name tech stocks and bets against emerging markets.

But many investors believe that a number of the factors that fueled the dollar's gains in 2018 are likely to fade. After rates were raised four times in 2018, investors are becoming increasingly convinced that dimmer global growth prospects may prompt the Federal Reserve to adopt a new wait-and-see approach to tightening monetary policy. Expectations of a slower pace of rate increases tend to make dollar-denominated assets, such as Treasurys, less alluring to investors seeking yield.

The dollar's attractiveness can also decline if the European Central Bank and other central banks begin raising interest rates after a long period of easing, narrowing the gap between yields in the US and other countries.

Analysts at Bank of America Merrill Lynch expect the euro to finish 2019 at $1.25, from around $1.15 now, as the dollar is weakened by political infighting in Washington, waning fiscal stimulus, and a more cautious Fed. (WSJ)