After three consecutive monthly increases, the trade-weighted U.S. dollar took a breather in July, shedding more than 1% as it declined against the euro, Canadian dollar, Australian dollar and Mexican peso, which altogether account for about half of the weight in the trade-weighted USD, explains the analysis team at National Bank Financial.
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“But one month does not make a trend. With trade tensions running high ─ and here we’re thinking about U.S. relations with China and Canada ─ the return of risk aversion and hence an immediate USD rebound cannot be ruled out over the near term. Moreover, the greenback could capitalize on more favourable interest rate spreads amidst tightening of U.S. monetary policy in response to an improving economy.”
“All in all, GDP growth this year (Q4/Q4) is on track to top 3%, the upper range of the Fed’s forecasts.”
“While it left the fed funds rate unchanged at 1.75-2.00% in early August, the Fed signalled an imminent rate hike by expressing even more optimism about the economy. It now sees economic activity rising at a “strong” rate, saying that household spending (which accounts for 70% of the economy) has “grown strongly”.”
“A September rate hike is now almost fully priced by markets, but the USD may yet get a boost next month should the Fed accompany the expected rate hike with bullish signals.”
“But with the fed funds fast approaching the neutral rate, the impact of rate differentials on the USD will fade and eventually reverse as other major central banks tighten policy. Also keep in mind the bloating U.S. budget deficit and fading impact of fiscal stimulus on GDP growth. As such, we continue to expect the trade-weighted USD to weaken next year.”
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