U.S. Dollar Seen Supported Until Global Economic Uncertainy and Fed Outlook Clear

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- USD to see "range bound" trading as uncertainty persists say analysts.

- Global growth needs to pick up and Fed stand still for USD to weaken. 

- And U.S. economy, inflation and wages must rise for USD to rebound.

The U.S. Dollar is likely to continue trading with a resilient tone and remain supported near recent levels over the coming weeks, according to multiple analysts, until uncertainty about the global economy and Federal Reserve (Fed) interest rate outlook lifts.

January saw the Dollar index cling tightly to its closing 2018 level while only a handful of select currencies actually managed to recoup any meaningful amount of lost ground from the global reserve currency, given elevated uncertainty about what lies ahead. 

Traders are attempting to gauge whether the global economy will stabilise during the months ahead or if the slowdown that begun in the second half of 2018 will endure through 2019. The answer to that question is just as important for currency markets as whatever the Federal Reserve decides to do next. 

"As long as the risks of a deeper global downturn remain large, it’s tough to see the USD weakening sharply," says Stephen Gallo, European head of FX strategy at BMO Capital Markets. "For now, it does indeed look like the major currency pairs are setting themselves up for a period of range-bound trading."

BMO's Gallo is not the only analyst to question the well-worn narrative that the Dollar will decline in the months ahead and for 2019 overall. Amherst Pierpont analysts broke ranks last week to say they expect the Dollar to rise this year, while others are now less certain about earlier projections of weakness.

"It should retain its strength against the low yielders of Japan and Europe, while still staying soft against high yielding G10 and EMFX currencies. This has been the core theme through January," says Chris Turner of ING Group. "Unless US-China trade tensions flare up again (talk of a Trump-Xi summit in late February should keep risk supported) or a No Deal Brexit becomes likely, we’d expect this cautiously risk positive environment to continue."

Above: U.S. Dollar currency index shown at daiily intervals.

Data emerging from the Eurozone and China began pointing last year to a slowdown in both economies, with manufacturing industries being at the forefront of the downturn. President Donald Trump's trade war with China is seen as the main source of the deceleration. 

China's central bank and policymakers have already attempted several times to support the economy with various forms of stimulus as a result, while the Europan Central Bank (ECB) has hinted strongly that it could now delay the date at which it lifts interest rates from their crisis-era lows.  

However, the outcome of trade talks aimed at ending the tariff fight between the U.S. and China will be key to whether or not the global economy does in fact stabilise. If a deal ending China's "unfair trading practices" is not reached before March 01, U.S. levies on some Chinese imports more than double to 25%. 

"The weaker wages report confirm to us the Fed is firmly on hold for now," says Joseph Capurso, a currency strategist at Commonwealth Bank of Australia. "However, most of our forecast USD depreciation is currently in H2 2019 because the current softness in the Eurozone, Japanese, and Chinese economies suggest the USD won’t depreciate much against these currencies"

Failure to end the tariff fight will could mean the global economy continues to slow, which might support the U.S. Dollar given many still see the global reserve currency as a "safe haven". 

However, an agreement that prevents another increase in tariffs would throw a lifeline to the Chinese and Eurozone economies, potentially encouraging a pick-up in growth during the second quarter that might then be bad for the Dollar. 

Above: Euro-to-Dollar rate shown at daily intervals.

Analysts say the Dollar would fall if the global economy were growing in lockstep with the U.S. economy because central banks elsewhere in the world have more headroom to lift interest rates than the Fed does now it's already raised rates eight times this cycle. 

However, those same analysts say the Dollar would benefit if the global economy continued to slow and the U.S. avoided a meaningful deceration. In other words, those who want to see the Dollar fall need either the global economy to pick up, or the U.S. economy to slow in the months ahead. 

"For the USD to sustain strong gains, FX investors will need to see price and wage developments that are “hot” enough to force the Fed back into its gradual tightening campaign," says BMO's Gallo.

Global economic risks may well have placed a floor beneath the value of the U.S. Dollar for the time being but are unlikely to be enough to sustainably lift the currency to new highs. For that to happen, some say the Fed would need to restart its interest rate hiking cycle first. 

The Fed raised interest rates four times in 2018 and has hiked a total of eight times since the end of 2015, citing inflation pressures that require tighter monetary policy in order for them to be brought under control. 

Those 2018 policy steps created an incentive for investors to sell other currencies and buy the Dollar because they came at a time when global growth was slowing and as many other central banks were sitting on their hands as far as interest rates go. The Dollar index scored a near-5% annual return last year.

Above: Pound-to-Dollar rate shown at daily intervals.

"The emergence of stronger than expected US economic data should help to ease downside risks for the US dollar in the near-term following the recent dovish shift in Fed policy. However, it is unlikely to prove sufficient to trigger a sustained turn around for the US dollar. The Fed has signalled strongly that they plan to keep rates on hold and have dropped their rate hike bias," says Lee Hardman, a currency analyst at Japan's MUFG. 

The Fed said last week that policymakers now intend to be "patient" while waiting for U.S. and global economic developments to dictate whether any further rate rises are going to be necessary over the coming quarters. 

This was widely interpreted as a signal that rates will remain where they are for as long as the U.S. inflation and economic outlook allows, which means another period of U.S. economic outperformance will be required if the currency is to rise this year, rather than succumb to the losses some forecast for year-end. 

Investors will not know for sure what kind of a start each economy got off to this year until mid-to-late April, which means the "range bound" trading forecast for Dollar exchange rates this week could yet endure for a while to come. 

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