Dollar-supportive factors may fade soon, says Wells Fargo

Longer-term dollar weakness likely as Fed approaches neutral policy, but how soon will that be?

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Holding on: Wells Fargo still sees trade tensions between the US and China as positive for the dollar

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Growth and interest rate trends that are currently working in the dollar’s favour could run out of steam in the medium term as expectations build for a slowdown in the US economy, and as the Federal Reserve slows its policy normalisation, says Erik Nelson, a currency strategist at Wells Fargo.

For now, the greenback’s momentum looks intact, as positive economic data points and inflation near the 2% mark mean the central bank is still on track to raise interest rates once more this year, following three in 2018 so far.

“The Fed is more or less on autopilot right now, and we expect another hike in December and three next year. However, at some point we expect the Fed to start [to] signal a slowing on policy normalisation, particularly as it approaches ‘neutral’,” says Nelson.

“That would be a key element in our longer-term dollar weakness narrative, although it’s not clear how soon that story could start to play out,” he adds.

In the short term, ongoing trade tensions and global market volatility will underpin the dollar. But US growth should begin to slow, says Nelson, as the fiscal boost fades alongside the pace of policy tightening, at the same time as other major central banks embark on policy normalisation.

The Fed is more or less on autopilot right now, and we expect another hike in December and three next year
Erik Nelson, Wells Fargo

“We think the European Central Bank will end bond purchases in December and start to raise rates around mid- to late 2019. It will be important to watch how the ECB is evaluating the ongoing situation in Italy, and whether that will have any influence on the pace or extent of policy moves. For now, we don’t think it will,” says Nelson.

“If it does start to impede the ECB’s normalisation plans, however, that would be a risk to our longer-term euro-bullish story,” he adds.

US-China trade tensions

For now, there is a keen focus on US-China trade tension, and its escalation has the potential to have an impact on the currencies of both nations. Trade developments have recaptured market focus in recent days, since US president Donald Trump said that he would expand tariffs to essentially all Chinese exports to the US – totalling about $500 billion in 2017.

Nelson expects USD/CNY to trade above 7.00, and stay there over a three- to six-month time horizon before eventually recovering. On November 7, the pair was trading around 6.93.

“We still see these tensions as dollar-positive, as the US remains a safe haven for investors and as the US has ‘the least to lose’ in a trade war. We also see the tensions as negative for the renminbi, to the extent they are met with more policy easing from Chinese authorities and slower Chinese growth,” Nelson says.

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