Global Macro Outlook January 2018

What’s Next for the USD: Macro Themes to Expect in 2018

  • In this last edition of the WFYI Global Macro Outlook for 2017, we look back at some of the dominant market themes in the year, as well as what that means for global markets moving into 2018 (using the USD as the focal point). 2017 was, by all means, a positive year for most asset classes and we see evidence of that in the fact that everything from the S&P500, to Emerging Market Equities and Commodity Markets experienced strong growth and historically-low levels of volatility. In the absence of geopolitical or macroeconomic black-swan events, this trend is expected to persist into 2018.

 

  • Guiding this thesis is the belief that the US Dollar is expected to persist its medium-to-long term bear trend, and thus market themes predicated on that trend are likely to continue. If we take a view of the multi-year chart of the U.S. budget deficit on the left, we see that the deficit shows signs of a structural downtrend – despite the U.S. economy experiencing a period of relative growth. We expect that this fiscal situation is likely to worsen over time, as weakening tax receipts and rising debt service costs force the budget deficit to widen. This is bearish for the USD as historically the US dollar weakens in response to a widening budget deficit.

 

  • Further guiding the bearish belief in the USD, is also its widening trade deficit, as imports increase without a corresponding balance in exports. At present, the US trade deficit is at its worst since May 2015, and as capital flows away from the U.S. increases, the corresponding value of the USD is likely to fall in conjunction with trends stated above.

  • The third reason for our bearish view on the USD in 2018 has to do with the idea of capital outflow relative to benchmark interest rates outside of the U.S. This is extremely peculiar because despite the U.S. being one of the few economies on a rate-tightening cycle (which is bullish for the currency), the U.S. Dollar has failed to appreciate in tandem. This, we believe, has to do with the broad-based reversal of multi-year trends in capital flows, with capital pouring back into non-U.S. economies like Europe and China, after having escaped those very economies in long period of NIRP (EZ) and fear (China). We believe this capital outflow is further supported by anticipations of monetary tightening in non-U.S. economies: policy decisions which are well supported by fundamentals.

 

  • Indeed, from a technical perspective, the chart of the Dollar Index (DXY) is indicative of a loss of long-term momentum with potential to move lower. As we can see, in the middle of 2017, the DXY pierced a multi-year support line, resulting in an intense and immediate plunge lower to the 92 level. The support range of 91-93 will remain key, and any violation of this range has the potential to move lower to the key 88 level.

 

  • This, ultimately, is our belief for where the US Dollar is headed in the medium-to-long term for 2018. If so, then we can continue to expect strength in Emerging Market Equities, EM Currencies, Commodities (Base Metals, Oil etc.) as well as Commodity Stocks. Conversely, we expect weakness in short-duration U.S. Fixed Income Instruments, as U.S. Consumer Staples stocks: all of which are assets predicated heavily on the direction of the US Dollar moving into 2018.

By Nicholas Tan Wei Hong