US Dollar Outlook Divides Analysts Even as Greenback Thumbs Nose at Fastest Growth for Four Years

-Dollar carries losses into new week as analysts clash on outlook.

-Morgan Stanley cites growth dynamics, positioning, for bearish view.

-Capital Economics cite relative interest rates for supportive forecasts.

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The Dollar eased lower Monday but analysts are divided as ever on the outlook for the US currency, which will be tested this week by the outcomes of several central bank meetings and stretched institutional positioning that is beginning to tilt against the greenback.

Most analysts agree it is only a matter of time before the Dollar downtrend of 2017 resumes although there is widespread disagreement over how soon the market will turn. Some say the Dollar could renew its earlier declines as soon as the middle of August, while others forecast that a turn will not happen until the New Year.

"Recently, economic data in the rest of the world (RoW) have started to beat expectations, at the same time as US data have started surprising on the downside. We expect this to continue as the positive impact of US fiscal stimulus and trade tariffs (front-loading of purchases before the tariffs take effect) on US 2Q growth fades. This convergence in global data should support USD weakness," says Gek Teng Khoo, an FX strategist at Morgan Stanley.

US GDP growth rose at an annualised pace of 4.1% during the three months to the end of June, up sharply from the upwardly-revised 2.2% pace of growth seen at the beginning of the year, but marginally below the consensus for a 4.2% increase.

This was the fastest pace of GDP growth for four years and the miss against expectations was miniscule but nonetheless, it was noted by the market. The US Dollar did not benefit from the eagerly anticipated report, as one might have expected. Instead, the Dollar index traded lower into weekend before getting off to a weak start on Monday. 

Above: US Dollar Effective Exchange Rate in 2018.

"We have seen the USD rally begin to peter out, perhaps aided by positioning. Bullish sentiment in USD is nearing contrarian overbought levels and the market is net short all G10 currencies except USD. Supporting this thesis of positioning driving markets, since Thursday CHF has been the best-performing G10 currency even despite risk performing well – and CHF is the shortest position in the G10," says James Lord, another strategist at Morgan Stanley. 

The performance of the Swiss Franc relative to other currencies in the last week hints at a possible reversal in market positioning, which would be consistent with the shift in global growth dynamics flagged by Khoo. 

Institutional money managers have thrown bucket loads of cash behind bets on the US Dollar in recent months, taking the total "net long" measured by Chicago Futures Trading Commission data to more than $44.4 billion last week.

This is the highest level since the aftermath of President Donald Trump's victory in the 2016 US election and is equal to 83% of the three-year maximum. Morgan Stanley's Khoo suggests a combination of a US slowdown and faster growth outside of the US could soon see the greenback come under pressure once again. 

This was exactly what drove the US currency to an annual loss back in 2017, when economic growth in the Eurozone was shown picking up strongly toward the end of the first half, while US economists had barely drawn a line under a first-quarter US slowdown when the growth picture was muddied further by a series of hurricanes that hit during the summer.

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

"Fundamental forces continue to suggest that USD is a funding currency, which implies a negative correlation to risk and positive macroeconomic outcomes in the Rest of World," says Lord. "Our four-factor USD scorecard continues to point to the current USD rally losing momentum around mid-August."

The Dollar index fell by 10% in 2017 and dropped another 4% during the first quarter of 2018, only to more than reverse those losses in April when it emerged the global economy had slowed during the first three months of the year. Quarterly Eurozone growth fell from 0.7% at the end of 2017 to just 0.4% while UK GDP growth halved to 0.2%. 

This saw the Dollar index convert a 4% 2018 loss into a 2.8% gain by Friday, 27 July, as investors bet that superior levels of US growth would enable the Federal Reserve to go on raising its interest rate at a time when central banks in Europe, the UK and elsewhere were in danger of getting stuck on hold. 

"We doubt that investors’ assessment of the prospects for monetary policy in other major advanced economies will change much this year. This means that relative rate expectations should generally move in the dollar’s favour," says Oliver Jones, an economist at Capital Economics. "With this in mind, we doubt that the dollar will give up the gains it made earlier this year until well into 2019."

The Bank of England is expected to raise its interest rate for a second time since the financial crisis this week, although markets are doubtful it will follow this move with another any time soon after.  The Fed is universally expected to raise rates in September and December, taking the Fed Funds rate up to 2.5%, the highest in the developed world by a country mile. 

The European Central Bank reiterated last week that its own interest rate will remain at record lows for some time to come and markets are doubtful the BoJ will make any meaningful changes to its monetary policy in the near future.

"By then, we think that the recent strength of the US economy have started to wane, bringing the Fed’s tightening cycle to an end sooner than investors are anticipating. And in the meantime, the central banks of other major advanced economies will probably be in the process of, or closer to, tightening policy. So relative interest rate expectations will probably start to move against the dollar," says Jones. 

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

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