May 21st

2018 Shaping Into a Better Year for the Dollar than 2017 Was

2018 Shaping Into a Better Year for the Dollar than 2017 Was

We are mid-way through the second quarter and at the three-eighths marker though 2018. The dollar, which ultimately dropped 12.3% against the euro in 2017 and at a similar point of last year had declined 4.1%, shows a scant 0.3% net uptick against Europe’s common currency this year. The dollar is also above its end-2017 level against the Swiss franc by 2.4%, and a number of commodity-sensitive monies like the Aussie dollar (3.5%), kiwi (2.2%) and loonie (1.8%). In all but one of those cases at this point last year, the dollar was already under water enroute to an even larger loss for the whole calendar year. The New Zealand dollar was the exception, and it ultimately closed 2017 also with a net rise.

  • The dollar also showed a 2.7% loss against the yen at this point last year, and that slide represents more than half its 3.6% drop in all of 2017. The yen’s decline this year could reflect the fact that while 10-year sovereign yields have climbed by 59 basis points in the United States and 18 bps in Germany, such is unchanged at a scant 0.04% in Japan. Although Japanese Prime Minister Abe’s voter support has eroded this year, his political opposition remains fractious, so it’s doubtful that the LDP would lose a snap election.
  • With a mere 10-1/2 months remaining from the original two-year Brexit countdown and with the British economy underperforming most other developed economies, it would not be surprising to see the dollar close out this year with a net advance against the pound.
  • China and the United States are engaged in competition for the hearts and minds of world opinion over which society is best organized to excel in the 21st century. The rivalry includes trade, and the yuan’s modest rise this year helps rebuff the accusation that Beijing officials are currently manipulating the yuan to bolster China’s trade surplus. From many respects, China appears to hold a long-term edge, but the dollar as the fulcrum of the international monetary system lends the U.S. a slew of advantages over China that will not be challenged in the short run.

The dollar has been buoyant against other emerging market currencies. Most notably, the Argentine peso has depreciated about 24% thus far in 2018 and about 37% compared to a year ago. A combination of large fiscal and current account deficits, inflation that soared as high as 40% and still hovers around 25%, weak growth, elevated unemployment, and failure of intervention and a sequence of central bank interest rate hikes to halt the flight of investor capital from Argentine assets has prompted the Argentine government to take the highly unpopular move of turning to the IMF for help. With a history of defaulting before and instances when problems in single indebted nations evolved into regional or global financial crises, investors are understandably uneasy once ago that the financial problems of one economy may infect others.

The world is already dealing with several geopolitical unknowns. The likeliest results of the coming Trump/Kim summit in Singapore are unsettling: either Trump lets North Korea off the hook but declares the deal to be great for the U.S. and the world, or the meeting completely breaks down, leaving Asia even closer to war than before this overture of peace. Escalating tensions between Iran and Israel also heighten the risk of all-out war in the Middle East. Meanwhile, U.S. abrogation of its leadership role among western allies diminishes prospects for the future success of democracies against the challenges of countries that would rather organize the globe along more autocratic lines. Finally, the U.S. congressional election, now less than a half year away, creates another wild card for financial markets and the dollar.

By benefiting from capital flows seeking safe haven, the dollar usually performs well in times of heightened geopolitical uncertainty. Even though the numerous changes in how the United States is being run have contributed to current investor jitters, the dollar is apt to benefit against this background for the time being.