Don’t bet on a strong dollar

By Oliver Mangan

The dollar has recovered some ground recently after a very shaky start to the year that saw it post significant losses in January and early February. The euro rose to as high as $1.255 in mid-February from $1.20 at the start of 2018, but has since fallen back to around the $1.23 level. Meanwhile, sterling has moved back down to around the $1.38 level, having traded as high as $1.43 in late January.

A relatively upbeat assessment of the US economy last week from the new Fed chairman Jerome Powell was supportive of the dollar.

Financial markets have also revised upwards their expectations for the course of US interest rates during 2018, which has benefitted the dollar recently. Meanwhile, eurozone inflation fell to 1.2% in February, its lowest level in 14 months.

This highlights that the ECB will be slow and cautious in terms of removing its very accommodative monetary policy, despite the marked strengthening of economic activity in the eurozone.

As a result, the spread between US and eurozone interest rates is set to widen even further this year as the Fed continues to tighten policy. Futures markets suggest that three-month interbank rates in the US will rise to around 2.5% by the end of 2018 compared to -0.25% in the eurozone.

The inconclusive outcome of the weekend election in Italy is an additional headwind for the euro. In fairness to the single currency, though, the dollar has been quite volatile against a broad range of currencies this year.

The dollar rather than the euro has been the principal driver of movements on currency markets recently.

The dollar’s gyrations are in line with a general rise in market volatility this year, most notably in stock markets. The latest factor to worry markets is the growing risk of a US trade war.

We don’t think that the modest recovery by the dollar in the past fortnight signals that its decline of the past year is over. We still believe that the dollar is on a long-term downward path as the big gains it made during the 2014 to 2016 period continue to unwind.

Indeed, the euro is still at a relatively low level against the US currency. We would not be surprised to see the euro reach close to $1.30 before the year is out. However, as the past fortnight has shown, we can also expect to see periods of dollar strength and a lot of volatility on currency markets during 2018.

Oliver Mangan is chief

economist at AIB.

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