Why US dollar may be spent force in 2018?

By Shen Jianguang Source:Global Times Published: 2018/1/11 21:36:48

Illustration: Peter C. Espina/GT

In 2017, the US Dollar Index ended its eight-year uptrend and declined by 10 percent throughout the year, making it the worst performing year since 2003. At the start of 2018, even under the dual boost of US tax reform and the Federal Reserve's interest rate increases, the dollar continued to weaken, which was outside the expectations of most market participants.

Here are some reasons why the US dollar's strength has been spent, and why observers expect it will be difficult for the currency to rise in 2018.

First, the US economy, which has not exceeded expectations, may hardly support the US dollar getting stronger. Looking back at 2017, although the performance of the US economy was not bad, it also didn't exceed expectations. In contrast, the European economy emerged from its debt problems, showing the strongest recovery since the financial crisis. As a result, the euro became the strong currency of 2017.

As for 2018, amid a global recovery, there is reason for optimism about the European economy. The positive signs of German property and strong exports, signals in Spain, which became Europe's economic bellwether after emerging from the debt crisis, and the effective control of European political and geopolitical risks from the possible soft Brexit all contributed to the economic recovery of Europe in 2017. The European economy is poised to get stronger in 2018, and the exchange rate of the euro against the US dollar will get stronger. It won't be surprising if the rate rises to 1.3.

Second, there are concerns about the medium-term effectiveness of US President Donald Trump's tax reform. Trump's tax reform was passed, which was good for the Trump administration. It may also give a boost to corporate profits and draw capital to stimulate the stock market and dividends in the short term.

But whether this tax reform can accelerate investment and the economy is still to be seen. After all, since 2000, the profitability of US companies has made great strides. However, due to low labor productivity and outdated infrastructure, US companies are not enthusiastic about investment, and the tax reform didn't change that.

In addition, Trump's tax plan is favorable for most of the rich and low-income people, while the majority of the middle class did not get any actual benefit and in some cases were even exposed to even heavier tax burdens. This will make the wealth gap worse in long run, and meanwhile it will curb the consumption of the middle class. At the same time, the long-term debt burdens caused by the tax reform may squeeze other much-needed expenditure in such areas as education, training and infrastructure.

Further, in this year's mid-term elections, if the Republican Party loses the dominance of either the Senate or the House of Representatives, Trump's policies will face even greater variables. Hence, the US dollar will be suppressed.

The tightening path of global monetary policy will also affect the trend of the US dollar. The monetary policy of major economies including the US, Europe, Japan and China may become tighter during the year. The market generally expects to see three interest-rate hikes in the US during this year. Nevertheless, Jerome Powell, the new chairman of the Federal Reserve, has been relatively dovish. Also, the experience of recent years has been that actual rate hikes are often below expectations at the beginning of the year. So there are also variables in the eventual rate hike results.

In the meantime, the European Central Bank's (ECB) balance sheet downscaling last year fell short of expectations, mainly due to concerns about the turmoil caused by the possible independence of Catalonia in Spain. Taking into account that the European economy is in its best situation since the financial crisis, if there is no special political upheaval, growth will maintain an upward trend, and this may also speed up the ECB's exit from quantitative easing.

In Japan, the economy is holding on to a mild recovery and achieving the longest period of growth since 2001. This means the ultra-low interest rates and extreme easing policy will gradually shift this year.

Finally, the US dollar may not appreciate after the Fed's interest rate hikes. An article in 2015 found that although the Fed has raised interest rates in seven cycles since the 1970s, the high-probability situation after a rate hike is a weaker US dollar. On two occasions, there were brief gains, but the Fed went back to cutting interest rates in these cases due to the negative economic impact of rate hikes.

In this context, depreciation pressure on the yuan will be further alleviated, and the Chinese currency may even benefit from a robust domestic economy and tightening of monetary policy under the deleveraging plan. The positive transformation of the external environment will create a window of opportunity for supply-side reforms such as prevention and mitigation of major risks, targeted poverty alleviation, pollution prevention, environmental protection and long-term mechanisms for real estate.

The author is chief economist with Mizuho Securities Asia Ltd. bizopinion@globaltimes.com.cn


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