US Dollar Outlook Brighter in New Year After Late-2019 Drop

US DOLLAR FORECAST: BULLISH

• US Dollar yield advantage may begin to drive gains if risk appetite holds up
• Iran conflict, trade wars, Brexit and US election may revive haven demand
• Service-sector ISM survey, December jobs report in focus on the data front

The US Dollar faced heavy selling pressure in the final three months of 2019, sliding to an eight-month low against an average of its major counterparts. Broad-based risk appetite improved in tandem, with the bellwether S&P 500 stock index rising to a record high. That points to the exodus of haven-seeking capital as the driver behind the currency’s weakness as US-China trade war and no-deal Brexit worries eased.

US DOLLAR HAS A YIELD ADVANTAGE VS. MAJOR CURRENCIES

As 2020 gets underway, the case for downward follow-through seems dubious. The Fed has embraced the idea that macro risks have diminished and worried aloud that low borrowing costs could fuel excessive risk-taking. That has served as the logic for stopping rate cuts. With seemingly no plans for tightening elsewhere in the G10, this locks in a USD yield advantage of 100-150bps against the major currencies.

If the global backdrop has indeed proved, that rates gap ought to attract returns-maximizing investors to the US unit at the expense of alternatives. If it has not, safety-minded demand for the Greenback’s unrivaled liquidity may well return to drive gains. This has already shown up in the markets’ response to escalating conflict between the US and Iran.

TRADE WARS, BREXIT, US ELECTION MAY REVIVE HAVEN USD DEMAND

Anti-risk demand may be buoyed by uncertainty about the next steps in US-China trade talks – where the truly substantive issues remain unresolved – as well as the possibility that a no-deal Brexit may yet occur absent a UK/EU trade deal by year-end. The US presidential election is another worry as investors weigh up a candidate pool seemingly offering moreanxiety-stoking scenarios than calming ones.

Rebuilding market participation levels after the holiday season lull and the allocation of portfolios for the new year will help show how markets see these narratives in the week ahead. The closely-watched service-sector ISM survey as well as December’s employment report headline the economic calendar. Recent deterioration in US data outcomes relative to baseline forecasts warns of disappointments ahead.

--- Written by Ilya Spivak, Sr. Currency Strategist for DailyFX.com

To contact Ilya, use the comments section below or @IlyaSpivak on Twitter

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