Dollar set for rough 2018 as the euro pushes higher, UBS predicts

  • The U.S. currency is set to have a disappointing 2018 against the euro despite the Federal Reserve likely to continue its current cycle of rate hikes into next year, according to currency experts at UBS.
  • A rise in benchmark rates is usually beneficial for the dollar as more people flock to U.S. assets in anticipation of higher yielding assets.
Euro Dollar
Stoyan Nenov | Reuters

The U.S. currency is set to have a disappointing 2018 against the euro despite the Federal Reserve continuing its current cycle of rate hikes into next year, according to currency experts at UBS.

A rise in benchmark rates is usually beneficial for the dollar as more people flock to U.S. assets in anticipation of higher yields. But Swiss investment bank and financial services group UBS believes the euro will out-muscle anything the greenback does next year. So far in 2017, the euro is up nearly 11.5 percent against the dollar.

"What matters for dollar is not the timing of the next hike," UBS strategists said, but "how far the Fed is likely to tighten over the cycle; and the market already expects a fair amount."

The strategists, writing in its 2018 global foreign exchange outlook released on Tuesday, said that comparatively the euro "remains cheap" and that "strong growth should catalyse appreciation." The euro has risen against the dollar this year amid improving economic data and a central bank that has just begun to reduce its mammoth package of monthly asset purchases.

Yianos Kontopoulos, UBS' global head of macro strategy and lead author of the outlook, said it had identified the currencies that UBS felt would "benefit most from a backdrop of solid growth, low but gently rising core inflation, and easy financial conditions that allows room for policymakers to normalize policy further in 2018 without accident." Here's some more detail from UBS' outlook:

The dollar vs. the Canadian dollar and the Japanese yen

"We expect the dollar dollar to perform well versus the Canadian dollar (CAD) and Japanese yen in 2018," Kontopoulos said. "The Canadian inflation outlook remains soft, as headwinds from recent CAD strength are likely to persist until the first half of 2018, and this should lead to further CAD weakness, in our view."

Meanwhile, for the greenback versus the yen, UBS said that Prime Minister Shinzo Abe's super-majority in parliament "bolsters the chances that the Bank of Japan maintains its accommodative stance."

"This suggests higher USD/JPY in 2018. As inflation rises, the yield curve target will likely be adjusted upwards, stabilizing the yen and ultimately leading it stronger."

Risk-sensitive currencies

When it comes to "risk-sensitive currencies," which tend to depreciate amid increased risk as investors seek perceived safe-haven currencies, UBS said "some are more attractive than others."

"In a solid growth and low but gently rising core inflation global environment, we expect risk-sensitive Aussie dollar, the Swedish krona and Norwegian krone to outperform," the Swiss bank noted.

"The Australian dollar should continue to find support amid resilient Chinese activity, supportive global financial conditions, and positive risk sentiment for carry. We also maintain our constructive Scandie view, as a solid macro backdrop that benefits further from the European recovery should support gradual appreciation of the Swedish krona and Norwegian krone through 2018."

Sterling and New Zealand dollar

Meanwhile, the New Zealand and British pound "wrestle political uncertainty," UBS said, with policy uncertainty in New Zealand following an election in September and ongoing Brexit drin the U.K. weighing on the currencies, respectively.

"We moderate our bullish New Zealand dollar view slightly despite kiwi screening as undervalued and its historically positive exposure to broad global growth. This is because policy uncertainty following the recent election may linger, and limit some of the New Zealand dollar upside," UBS said.

For sterling, UBS said its bearish view for the pound "remains intact as a decelerating economy compounds uncertainty around Brexit negotiations."