A dollar rally that has pressured everything from emerging markets to commodities in 2018 is reversing into the year’s end.
The ICE Dollar Index, which measures the U.S. currency against a basket of six others, has given up around a third of its gains from the year’s first eight months, falling 1.7% from its August peak.
A number of factors have dovetailed in recent months to weigh on the dollar. A gradual U.S. approach toward imposing tariffs on Chinese goods has sparked hopes that the U.S. and China may eventually resolve their trade dispute, encouraging investors to cut back on haven bets such as the dollar and shifting into U.S. shares and beaten-up emerging-markets currencies and stocks. That could pressure the dollar in coming months.
This trade conflict between the world’s two largest economies had buoyed the greenback earlier in the year, with many investors believing the U.S. would be less damaged than other countries in an all-out trade war.
“Risky assets look a little bit more attractive and investors are looking to dip their toes back into other asset classes,” said Mark McCormick, North American head of foreign exchange strategy at TD Securities.
The dollar also has been weighed down by signs of burgeoning growth outside the U.S. European Central Bank head Mario Draghi in September delivered an upbeat assessment of the region’s economy and confirmed a plan, announced in June, to wrap up the ECB’s €2.5 trillion ($2.91 trillion) bond-buying program by the end of the year. Meanwhile, Japan’s economy returned to growth in the second quarter after a contraction in the first three months of the year.
At the same time, many investors already anticipate four interest-rate increases in 2018. The Federal Reserve raised rates for the third time this year in September and is widely expected to raise them once more in December. While tighter monetary policy in the U.S. typically makes the dollar more attractive to yield-seeking investors, some believe the market already has factored the next few rate increases into the currency’s price.
Taken together, these factors have damped investor enthusiasm for the U.S. currency.
“We believe that dollar strength, based on macroeconomic and monetary-policy divergence, has almost run its course,” analysts at the Wells Fargo Investment Institute wrote in a recent note to clients. They expect the dollar to remain flat against the euro for the remainder of 2018 and depreciate against the common currency next year.
A weaker U.S. currency would offer some relief to the battered currencies of emerging-markets countries where dollar strength has contributed to turmoil in recent months, such as Turkey, Argentina and South Africa. These nations, along with many other developing markets, accumulated large amounts of dollar-denominated external debt in recent years, which became more difficult to service when the dollar and U.S. yields rose earlier in 2018.
It would be less welcome in Europe and Japan, whose weaker currencies have helped fuel impressive economic rebounds. The ECB expects “a relatively vigorous pickup in underlying inflation,” Mr. Draghi said in September. Weakness in the dollar can boost other currencies, such as the euro, smothering nascent inflation in the eurozone and other economies.
In the U.S., the dollar’s downshift could ease pressure on multinational companies whose balance sheets have suffered because they need to convert foreign profits into the U.S. currency. It also could help buoy commodities such as oil, gold and copper, which are priced in the U.S. currency and become more affordable to foreign buyers when the dollar depreciates. Oil prices are up 17% from their mid-August lows, while copper prices have risen 9%.
Write to Ira Iosebashvili at [email protected]