The US dollar defied expectations in 2018, rising by over 10.5% against a trade-weighted basket of competitors. Forecasts that the ‘rest of the world’ (RoW) would catch up proved misguided. In the end, RoW fell even further behind, and the dollar surged ahead.
The first boost came after the US Congress approved an extension of the US debt limit in February. The approval of a further $300bn in government spending, suggesting substantial stimulus, further supported the greenback. The dollar shrugged off so-called ‘twin deficit’ fears and rallied higher as markets took the view that increased growth would offset the cost of borrowing.
In March the dollar took a temporary hit as the first salvo of the tariff war began with duties on aluminium and steel. Gold, being the usual safe bet, had to step back as fearful investors chose the USD as their safe-haven of choice.
The dollar motored higher in April as the US economy really started ‘cooking’. Growth in Q2 rose 4.2%. US interest rates surged on expectations of higher inflation. A major landmark moment was when the 10-year US Treasury bond yield rose above 3.0%. The dollar Index rose over 2.0% in April alone.
In May, the dollar continued to rise after the collapse of the Turkish lira began a backslide for other fragile emerging markets (EM). Not long after, the Indian rupee, South African rand, and Indonesian rupiah had all joined the list of EM casualties. The currencies most at risk were those with high dollar-denominated debts which grew more expensive to service as their currencies devalued against the buck. This began a vicious cycle of increasing unaffordability, devaluation and even less affordability. The trade-weighted dollar extended its lead over the pack, rising over 2.2% in May.
Midyear the dollar paused for a rest. It further eased in August and September on the view that the US economy had peaked and everything would be downhill from here. A rise in short-term interest rates made hedging US assets more expensive in the Autumn further weighing on the dollar.
As Q4 began the dollar ‘got its act together again’ and recovered. Growth continued to surge higher, registering a 3.5% rise in Q3. Expectations interest rates – the main driver of currencies – would also rise, further fuelled the rally. Fed Chairman Powell poured gasoline on the fire by saying the Fed would raise base interest rates to beyond ‘neutral’.
The Democrat victory in the US-midterms sent the US dollar lower but only temporarily. Safe-haven flows from trade war fears triggered a recovery but then eased in November after China and the US signed a ceasefire at the G20 summit.
The dollar ended the year mixed as fears of economic slowdown weighed. Trade tensions re-emerged after the arrest of a high-profile Chinese business executive in Canada on charges of defying US trade sanctions, raised the prospect a return to a diplomatic standoff between the two superpowers.
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