US Dollar Forecast 2015 / 2016: Significant Gains Ahead Says Leading Investment Bank

Last Updated: 13 August

Goldman Sachs' strategists believe speculators should expose themselves to the US dollar now as they forecast substantial gains ahead.

The US dollar exchange rate complex (USD) has been trending sideways since it peaked in March. The US dollar basket – the measure of the currency against its major rivals – hit 103.31 on the 16th of March.

The market unravelled somewhat on this over-extended move and it has been moving sideways since.

However, since June we have witnessing an attempted recovery; this recovery has much further to run according to Goldman Sachs who have told clients that now is the time to buy into the dollar rally.

“We see recent shifts from the Fed and Bank of England – the two G10 central banks closest to 'lift-off' – in a similar light. Appreciation pressure on the Dollar and the Pound may delay 'lift-off', but – with policy rates so far below neutral – both central banks will ultimately have to accept stronger currencies,” says a note to clients.

Goldman have reiterated a call for the Dollar to rise 20% in the next three years and expect the pound to rise 12% over the same horizon.

Regardless of the exact timing of the first interest rate rise at the US Federal Reserve and the near-term path of data, more risk premium needs to come into front-end US rates, which is Dollar positive.

“A further tactical consideration is that falling oil prices may be raising the odds of additional monetary stimulus in places battling deflation, with the Euro area and Japan front and centre. Dollar upside remains large, and it’s time to grab some,” say Goldman Sachs.

According to analysts much of the rise in the USD has come on the back of external drivers – for instance ECB and BoJ monetary easing, this being opposed to US interest rate normalisation.

“We think genuine Dollar strength – driven by reduced policy stimulus – has yet to materialise,” says the client note.

Tactically, Goldman Sachs think now is a good time to position for Dollar strength.

“That is because some of the progress the Fed made last year towards data dependence has been undone since the March FOMC, when Chair Yellen memorably said that dropping “patient” does not translate to impatience.”

Since then, the bank’s estimate for the sensitivity of two-year yields to US data surprises has fallen back to near ‘calendar guidance’ levels, “meaning that – even though it de jure abandoned forward guidance in March – de facto the market sees the Fed as having gone into reverse.”

It is argued that this matters for the Dollar because the dilution of forward guidance last year was an important Dollar positive in the weeks following the September and December meetings.

Dollar upside is also actionable because falling oil prices are most obviously a threat to those places – the Euro area and Japan – that are battling deflation.

Last year the market sold the Euro and the Yen alongside the commodity dollar currency familly, but the recent drop in oil prices has seen the Euro and Yen decouple from the likes of AUD and CAD.

It is argued that this is a sign that the foreign exchange market sees little chance of additional monetary easing coming from Japanese and European authorities.

This is too a complacent view argue Goldman Sachs who believe the market is – falsely – dismissing the threat that falling oil prices pose for the deflation fight in the Euro area.

This might be because growth has improved since last summer and the recent jump in core inflation to 1.0% year-over-year. But, it is argued, the recent jump in core HICP, which Goldman Sachs expect to reverse somewhat anyway, remains consistent with their view that the Euro area Phillips curve has shifted down.

“Much as last summer, it will be key to see if falling oil prices spill over into inflation expectations, where the fall so far has been relatively muted,” says the client note.

In Japan, it would take a herculean rebound in sequential core inflation to reach the BoJ forecast of 0.7% for FY2015, even if a new inflation measure from the BoJ (that excludes energy and fresh foods but includes processed foods) shows a better inflation trend.

“In both Japan and the Euro area, the odds of additional stimulus may be rising, a further reason to be long Dollars,” say Goldman Sachs.

Clues on Fed Rate Hike

Today will be released the retail sales data for July.

Estimates report a change increase of 0.6% from -0.3% in June, mostly driven by strong vehicle sales. Initial jobless claims (New people filing for unemployment benefits) will also coming in today.

“This data is expected to remain in line with prior figure at 270K. Last week non-farm payroll report printed lower than expected at 215k vs 225k. We are still thinking that data are not fully supporting a September rate hike,” says a note on the subject from Swissquote Bank in Gland, Switzerland.