The US dollar is looking vulnerable
The US dollar is particularly sensitive to growth and rate differentials between the US and other major countries. The growth differential has helped support the US dollar of late, thanks in particular to the tax cuts announced in late 2017 by the Trump administration and the negative impact of trade tensions on major economies more reliant on exports than the US. As a result, the US economy has been quite resilient while the rest of the world has suffered a fall in growth momentum.
However, our central scenario for 2020 is for a significative deterioration in those two key drivers as the Fed responds to weakening US growth (GDP growth of 1.3% vs. 2.2% in 2019) by launching a proper easing cycle. Other major economies may prove more resilient in 2020 (our central forecast for world GDP is 2.9%, slightly down from 3.0% in 2019), meaning that the US’s economic outperformance is set to end, with negative consequences for the greenback.
Meanwhile, the dovish turn by the Federal Reserve (Fed) at the start of 2019 coupled with the three ‘insurance’ cuts it pushed through in 2H 19 have led to a narrowing of a US dollar-friendly rate differential. Weakening activity should open the way for a full-blown easing cycle next year. Indeed, our central scenario foresees four 25bps rate cuts by the Fed in 2020, starting in late Q2. This should accelerate the narrowing of the rate differential (especially as the Fed has significantly more room to cut rates than other major central banks) and further hurt the greenback’s attractiveness.
While its defensive and high-yielding features could help the US dollar, it is unlikely a decline of the US dollar index (DXY) can be avoided next year, notably because of the greenback’s fundamental overvaluation and our forecast that global growth will stabilise at low levels.
We estimate a decline of roughly 4% in the DXY over the next 12 months. Defensive currencies such as the Japanese yen and Swiss franc should appreciate the most against the US dollar (we have a 12-month projection of JPY100 and CHF0.92 per dollar, respectively). We remain somewhat cautious on commodity currencies, notably because of our downbeat forecast for oil prices in 2020.