What has been behind the US Dollar’s recent poor performance?

nvestors mostly overlooked Wednesday’s lofty inflation numbers that suggested that Federal Reserve could be on course to raise interest rates on as many as four occasions in the US in 2018. So what factors have been behind this recent sharp downtrend? Concerns this week appear to have shifted towards the country’s growing current account deficit. Recent tax cuts from the Trump Administration are expected to fuel domestic demand in the US. While this should foster higher growth, it may have the unwanted side-effect of worsening the balance of trade and swelling the current account deficit – often a key consideration for investors during periods of market stress.

Meanwhile, there are some concerns that the recent, prolonged economic expansion as part of the latest business cycle could be coming to an end. The US economy has grown in almost every quarter since falling into recession in 2009, with its current run of growth (104 months) the third longest consecutive period of positive expansion on record. Donald Trump’s ongoing war of words with major political leaders has also far from helped matters, while the uptick in global growth and recovery in equity markets has improved sentiment towards riskier currencies.

However, we stand by our call for a reversal in the US Dollar’s fortunes in the coming months. While it appears to have taken a back seat of late, the key to foreign exchange rates movements remains investor’s expectations for future interest rates. Should the Federal Reserve signal that it is ready to hike rates at a faster pace than the market is currently pricing in at its March meeting, as we expect, we think we’ll see a recovery in the greenback against most major currencies this year.

Euro rises to highest level since 2014 in trade-weighted terms

In the currency markets yesterday, the Euro made a fresh charge upwards, although found some resistance at the 1.25 level. A swelling in the country’s trade surplus to €23.8B in December highlighted the contrasting external positions between that of the US and the Eurozone. This was enough to send the currency to its highest position in trade-weighted terms since 2014. A speech from ECB member Benoît Cœuré today bodes to be the only announcement of note in an otherwise quiet end to the week in the Euro-area.

Sterling also edged higher against the broadly weaker US Dollar. Markets continued to ramp up expectations for another interest rate hike by the Bank of England in the coming months. The market is now pricing in around a 70% chance of a hike at its May meeting following a survey published by the BoE on Wednesday that showed British workers were in line for their largest pay increases since 2008. Retail sales data this morning were soft, although the Pound mostly held its own following the release.