US Dollar Poised for Strong 2018 Finish as Perfect November Storm Gathers Overhead

-USD to end 2018 on the front foot, but midterms are key.

-USD upside ahead of midterms, as Trump doubles down on trade.

-But election outcome will determine USD outlook after November.

© Gage Skidmore

The Dollar is poised for a strong 2018 finish because a perfect storm is gathering overhead as the November midterm election approaches, which analysts at ING Group say will place "pro-cyclical currencies" under continued pressure, enabling the greenback to hold some of its recent gains for New Year.

That's not to suggest that the Dollar will not cede some recently-acquired ground during the months ahead, because almost all forecasts suggest that it will.

However, the Dollar has proven more resilient in 2018 than most thought it would and the strong US economy, combined with President Donald Trump's belligerance in the international trade arena, are set to persist for a while yet.

The ING team say this, and other factors, will mean the Euro-to-Dollar rate struggles to recover meaningfully before year end. And even with an anticipated Brexit deal coming late in 2018, Sterling is forecast to recover only modestly against the greenback before the clock strikes midnight on December 31. 

"Buoyed by a strong domestic economy and a stock market inflated by repatriated corporate profits, the White House continues to look for concessions from major trading partners. We see no let-up in this protectionism ahead of November US mid-term elections, spelling trouble for pro-cyclical currencies," says Chris Turner, global head of currency strategy at ING Group. 

Both Sterling and Euro are cyclical currencies, particularly when stood next to the US Dollar, and both have fallen sharply since the middle of April. 

The Pound-to-Dollar rate has been dented by rising unease about the trajectory of the Brexit negotiations, which have seen a political risk premium priced into Sterling and are preventing the market from recognising an otherwise reasonable economic performance from the UK and a steep discount to "fair value" for the currency. Sterling is down 3.5% against the Dollar for 2018, after rising nearly 6% during the opening months of the year.

"A lot of bad Brexit news is priced in and a last-minute deal on the Irish backstop means that risk-reward no longer favours pricing in no-deal Brexit risks – with any sharp GBP rebound in this scenario (1.36 in 6 m) now outweighing momentum-driven moves lower," says Viraj Patel, an ING colleague of Turner's, in the bank's latest currency outlook. 

Meanwhile, the Euro-to-Dollar rate was hit by the slowing pace of Eurozone economic growth, which declined from 0.7% at the end of 2017 to 0.4% for the first two quarters of 2018. An uncertain outlook for continental inflation has also been at play, which prompted the European Central Bank (ECB) to warn in June that it will be "through the summer of 2019" before the governing council becomes willing to indulge markets with an initial interest rate rise.

Until then, traders had been betting the ECB would lift its interest rate in June 2019, after gradually winding down its bond buying programme throughout the second-half of 2018. The above factors helped the EUR/USD rate convert a 4% first quarter gain into a 3.2% 2018 loss during the six months since March. 

"US equities have been insulated from the Trump trade agenda by the 2018 tax cut. US corporates repatriated a massive US$170bn in 1Q18 – largely for share dividends and buy-backs," says Turner. "EUR/USD is vulnerable through September, but the resolution of Italy’s budget in October and Trump’s concern over dollar strength should keep the downside relatively limited below 1.15."

Both the Pound-to-Dollar and Euro-to-Dollar exchange rates have also been driven lower by a broad strengthening of the greenback, which has recently converted a 4% first quarter loss into a 3% 2018 gain thanks to a superior US economic performance and a global deterioration of investors' appetites for risk. 

With tax-cut-induced growth aside, President Donald Trump's "trade war" with China has been at the centre of this shift because it has prompted investors to shun currencies that could adversely impacted if the tariff fight between the world's two largest economies descends into all-out economic war. 

President Trump has announced the intention to impose tariffs on more than $250 billion of China's exports to the US and threatened at the weekend to target the full $500 odd billion of goods the world's second largest economy sends to its North American rival every year unless its leadership changes course on its international trade practices. 

The US alleges that China uses "unfair" trading practices that, among other things, force American companies operating in the country to hand their intellectual property over to Chinese companies. Combating these practices was a key part of President Trump's electoral campaign offering and is among a range of issues that he has long spoken out against. 

"We think the Democrats will win the house – and noise about impeachment will certainly rise – but there is no clarity on how far this escalates. Equally there is little clarity on whether a swing in the House to the Democrats is enough to curb protectionism, given the enormous powers the President has over trade policy," says Turner. 

Given how popular the "America First" agenda proved in the 2016 presidential election, fears are that Trump will double-down on his trade agenda ahead of the November midterm elections, which threaten to hand a House of Representatives majority to the opposition Democratic Party. 

This would make it easier for Democrats to get the ball rolling on the impeachment process. It's not clear exactly what they would attempt to impeach Trump for, but opposition politicians have used the idea of impeachment as a rallying cry for supporters ever since November 2016. 

At the least, this would make implementation of substantial parts of the administration's agenda a lot more difficult. In turn, that would reduce the prospect of further tax reforms or more fiscal stimulus being passed in Congress, which would otherwise have offered short-term support to the Dollar.

In a nutshell, the run-up to the midterms is expected to be supportive of the greenback but there is uncertainty about the outlook for the currency in the period between then and year-end.

Turner and the ING team forecast the Pound-to-Dollar rate will finish 2018 at 1.33, down from 1.34 at the beginning of the year. The Euro-to-Dollar rate is forecast to close the year at 1.17, down from 1.1935 at the beginning of January 2018.

This suggests the US currency will hold on to at least some of its recent gains, even if ING are right in predicting the Democrats will be a step closer to impeaching Trump after the midterms.

The Pound-to-Dollar rate was quoted 0.83% higher at 1.3021 Monday while the Euro-to-Dollar rate was 0.47% higher at 1.1604. 

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