Short to Medium-Term Outlook for USD

One of the key calls I have for the year, is that the USD will continue to strengthen. It is one of the more critical calls to get right, as it has ramifications on the wider portfolio. YTD the USD is down around 1%, as measured using the dollar index DXY, with other major currencies such as the Euro, British Pound and Yen all showing relative strength. It is though still significantly up on a 1, 3 and 5-year view, so the question is, is the upward trend over or are we mean reverting back to 2014 levels.

In my view, the key drivers for a stronger USD, are the following:

1. A rising rate environment, with the Fed being the only major central bank raising rates and having an economy strong enough to at least withstand some increase in nominal rates. Japan and Europe are also seeing inflation pick up, but their central banks are likely to lag in terms of the rate cycle.
2. Trump’s policy of reducing trade flows into the US may also be beneficial to the USD, as fewer dollars are sold to buy the exporters’ local currencies.
3. Should offshored assets held by US companies be repatriated, that should as well be a positive driver. There is some $1trl of offshored cash that could in part be repatriated back, should some form of amnesty be worked out, something which is likely given Trump’s policy to get American capital back into the US to drive American jobs.

To be honest though, while the above has merit, core to my expectation of a stronger dollar is that a major trend like this normally continue until there is a blowout. My expectation is that this will come in a few years time and be coincident with a blow-up in one of the emerging markets that have significant exposure to USD denominated debt, such as Turkey. This may or may not be coincident with a larger global slowdown.

The bulk of debt is still USD denominated and, as interest rates rise and the USD strengthens, this will put pressure on borrowers to pay the debt down, further driving the USD higher. The Fed is very cognisant off this, but should inflation pick up without a similar pickup in growth, borrowers will slowly get squeezed in the middle. Certainly, if we have more than this, the dollar will rally more aggressively, on the back of its current reserve currency status.

So to some extent it is a hedged play – get a stronger global and US economy the USD should strengthen on the back of higher relative rates; get a shock to the system and the USD should strengthen on the back of a flight for safety. Trump may want to talk the currency down but, from where I am sitting, it still has further to go.