Policy divergence to drive dollar outlook
The US Dollar Index (DXY)(UUP) has risen 8.3% since its low on February 15. The recent run to safe-haven assets following the tariff announcements, in concert with the Fed’s hawkish tone, has supported the US dollar. The tone of the ECB’s (European Central Bank) was more dovish than expected last week and supports the monetary policy divergence theory, which currently favors the US dollar.
However, the Fed is on a tightening path. So, a loose monetary policy followed by the European Union and other major trading partners of the US could increase the dollar’s attractiveness. On June 18, the US Dollar Index regained strength and rose to 11-month-high price levels.
Improved relative performance of the US
The bullishness in the US dollar (USDU) in the last couple of months is mostly related to US economy’s improved performance compared to most of the rest of the developed world. The economic data out of the US remains positive while the risks elsewhere, including in the European Union (HEDJ)(VGK), continue to mount. The surging US bond (IVV) yields also helped the US dollar.
While the rally in the US dollar might have dominated the foreign exchange markets for the last few months, that could be about to change. The markets have already priced in the rate hike trajectory by the Fed and the policy divergence theme.
If the trade war escalates further, the US dollar might not dominate as a safe-haven asset. Uncertainty regarding the United States’ trade policies might negatively impact the market risk appetite for the US dollar. Medium- to long-term concerns of the twin rising US deficits impacting the US dollar negatively are still in place.
A weakening US dollar outlook bodes quite well for gold prices (IAU)(NUGT), which have weakened in 2018 mostly due to the stronger dollar. Please read Bulls versus Bears: What’s Driving Gold? for more insight into other factors driving gold prices.