The US dollar has been the whipping boy of currency traders over the past year.
In 2017 alone, the US dollar index, or DXY, fell by 10%, losing ground against all major currencies. And that weak performance has carried over into the early parts of 2018 with the DXY down a further 2%.
However you chose to describe it — be it relentlessly, monotonously or other — the US dollar has come under significant selling pressure.
Put simply, it just can’t find a friend.
Elias Haddad, Senior Currency Strategist at the Commonwealth Bank, says the US dollar is unlikely to find many new friends in the year ahead, either, but thinks the chances of a short-term bounce in the DXY are increasing given market sentiment and positioning are all stretched in the same direction.
“The USD is vulnerable to a technical relief rally in the short-term but we continue to expect the USD to trade on the defensive this year,” he said in a note released earlier this week.
In particular, Haddad nominates four specific factors that will likely weigh on the greenback: weak inflationary pressures, further rate hikes from the Fed already factored in to the dollar’s valuation, a move towards less accommodation monetary policy settings from other major central banks and an improvement in the global economy, something that tends to weaken, rather than support, the DXY.
On the inflation outlook, Haddad says soft inflationary pressures will not allow for markets to price in additional rate hikes from the Federal Reserve.
“Benign US inflation pressures will limit a significant upward revision to US interest rate expectations,” Haddad says, noting that the Fed’s preferred inflation reading — the core PCE deflator — has been below the Fed’s 2% objective since May 2012.
“Interestingly, the FOMC still projects the core PCE deflator to only reach 2% in 2019 even when accounting for the prospect of greater fiscal stimulus.”
Along with weak inflationary and wage pressures, Haddad says the US dollar is unlikely to get much support from further rate hikes from the Federal Reserve.
“Fed funds rate rises are largely priced,” he says. “Fed funds futures have fully discounted two 25bps rate hikes for 2018.”
And even if the Fed is more aggressive, delivering three hikes as it did in 2017, Haddad still doesn’t think it’ll be enough to support the dollar.
“The FOMC can potentially deliver three 25bps rate increases this year. But one more rate rise than is currently priced-in will not be a major sustained tailwind for the USD,” he says.
And with each rate hike from the Fed taking it closer to the end of its monetary policy tightening cycle, Haddad says other major central banks are just embarking on that path, something that he expects will continue to support other major currencies to the detriment of the dollar.
And that’s especially for the euro, the largest component in the US dollar index at well over 50%.
“There is greater scope for less monetary policy accommodation from other major central banks,” says Haddad.
“For instance, Eurozone overnight index swaps (OIS) show just a 30% probability of a 10 basis point lift in the European Central Bank (ECB) deposit rate by year end to -0.30%.”
Haddad says that interest rate expectations from the ECB “can adjust higher sooner because leading indicators are consistent with firmer Eurozone GDP growth and accelerating inflation”.
Further aiding other major currencies, Haddad also says that sychrnoised and strengthing global growth should also act to support cyclical currencies such as the Australian, New Zealand and Canadian dollar’s.
“The global economy is experiencing its first synchronised expansion since 2007,” he says.
“[This] chart shows that the USD tends to underperform when global growth is improving. Stronger global growth will support commodity prices which bodes well for AUD, NZD and CAD.”
As for the risks to his downbeat view on the dollar, Haddad says they come from a sharp increase in financial market volatility or significantly faster tightening cycle from the Fed.
“A faster pace of Fed funds rate hikes and/or a pick-up in financial market volatility are upside risks to our bearish USD view,” he says.
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