What’s on the plate for the dollar

The dollar outlook is mixed

Weakness in the dollar is one of the major factors that pushed up the rupee in 2017. Despite the greenback managing to remain broadly stable in a sideways range so far this year, the rupee has weakened. Here, we take a look at what could be driving the dollar.

 

The positives

The recent tax reforms in the US, which included a major corporate tax rate cut from 35 per cent to 21 per cent, reduction in individual tax rates etc, are likely to boost the dollar.

According to the European Central Bank’s Economic Bulletin, this reform will be a significant fiscal stimulus for the US that could boost domestic demand and push up growth to 1.3 per cent from around 0.5 per cent.

The US Federal Reserve has also acknowledged the strength of the economy that is evident from higher growth revisions made last month for this year and the next. The US is projected to grow at 2.7 per cent in 2018, up from 2.5 per cent projected in December.

For 2019, the growth rate has been revised higher to 2.4 per cent from 2.1 per cent projected earlier in December.

As of now, there is no change in the Fed’s plan for three rate hikes in 2018, with the first round of rate increase already done last month. If the Fed changes its stance and decides to increase rates at a much faster pace on the back of a strong economy, it could be a boost for the US dollar.

The negatives

The US President beginning a trade war by imposing tariffs on aluminium and steel imports last month and considering an additional tariff worth $100 billion on Chinese imports has jolted the global markets. China has also retaliated recently by imposing tariffs on US goods.

The US is targeting China with which it has a wide trade deficit; as on 2017, the US runs a trade deficit of $375 billion with China.

If the trade war gets intense, it will be negative for the dollar, as the US producers will be hurt by the compulsion to import at higher prices from other countries when compared to China.

The tax cuts announced by Trump are expected to widen the US budget deficit above $1 trillion in the next couple of years.

According to forecasts, the deficit is expected to increase to $804 billion in 2018 from $665 billion in 2017 and then breach $1 trillion by 2020. Financing this deficit is expected to increase the supply of US bonds, applying pressure on yields. This is expected to be negative for the dollar. 10-year bond yields have moved up from 2.40 per cent to 2.83 per cent in this calendar.

Three, any early hints from the Fed’s counterparts, the European Central Bank (ECB) and the Bank of England (BoE) on their policy tightening in the coming months can hurt the dollar.

The ECB will be closely watched to see if it cuts down asset purchases, currently at €30 billion a month until end September this year.

The BoE has come into light after two of its members voted for a rate hike in March. Any change in the stance of ECB and BoE could turn the market risk averse and see the dollar weakening against the euro and the pound.

Takeaway

Broadly, the outlook for the US dollar is mixed. While a short-term weakness in the dollar cannot be ruled out, the greenback could remain in a broad sideways range.

ALSO READ: Rupee: What the charts say?

Rupee — what lies ahead

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