After A Weak 2017, Can Dollar ETFs Rebound In 2018?

The king dollar has completely lost its stature in 2017 on geopolitical tension and uncertainty regarding the passing of President Donald Trump’s proposed policies. Even two rate hikes by the Fed could not put upward pressure on bond yields for the most part of 2017, which undermined dollar’s strength. PowerShares DB US Dollar Bullish ETF (NYSE:UUP) UUP and WisdomTree Bloomberg US Dollar Bullish ETF USDU are off 8.5% and 7.7% so far this year (as of Dec 8, 2017).

Now, speculation over fiscal stimulus likely to be introduced by the President, prospects of lower taxes, an easier regulatory environment, more domestic job creation and compelling valuation should take the greenback to another height.

What Lies Ahead in 2018?

Though the year has not treated the currency well, 2018 could bring about positive changes. Below we highlight a few reasons that could push the greenback higher next year.

Frequent Fed Rate Hikes

Most analysts are expecting the Fed to act aggressively next year given the upbeat U.S. economic growth. Deutsche Bank (DE:DBKGn) believes that the Fed could hike interest rates as many as five times by the end of 2018. This means a sharp rise in the greenback.

To keep the U.S. dollar steady, the Fed will have to react more frequently. Note that Goldman Sachs Group (NYSE:GS) predicted in September that the U.S. dollar will surge 15% based on expectations of a three-percentage-point rate rise within the Fed tightening cycle through 2019 (read: Follow Goldman's Call on Dollar with These ETFs).

In fact, we are likely to see a Fed rate hike this month. Many economists also believe that the economy will likely ricochet from the fourth quarter thanks to a pickup in activity in the hurricane-affected areas. This means 2018 would be ready for tight monetary policies right in the beginning (read: Fed to Hike in December? Buy Quality ETFs).

Easy-Money Policies in Other Developed Nations

Plus, several foreign economies including Japan and the Eurozone are still practicing ultra-easy money polices which should keep their currencies low, giving the greenback an edge over these developed currencies.

Likely Tax Reform

As the tax reform in the United States seems to be a few steps away from enactment, chances of a rebound in the greenback area higher now. Bank of America Merrill Lynch (NYSE:BAC) noted that the currency is up for a recoil next year if the GOP tax plan is passed (read: Senate Passes Tax Bill: 5 ETFs to Buy Now).

Under the tax-reformed environment, companies would be interested in repatriating cash they stacked overseas for tax evasion. Naturally, some of these would be converted to dollars and used for capital expenditure. The research house expects tax cuts to enhance annual gross domestic product growth by 0.3 to 0.4 percentage points over the next two years.

The house also believes "almost nothing" on taxes are baked in at the current market price. Tax cuts would boost economic growth, leading the Fed to hike rates faster than expected, the firm's FX strategists indicated (read: 5 ETFs to Buy for 2018 if Infrastructure Reform Kicks In).

Compelling Valuation

Having slid about 8% this year, the currency now speaks of undervaluation. Historically, the United States Dollar touched an all-time high of 164.72 in February 1985 and a record low of 71.32 in April 2008. With the U.S. dollar currently hovering around 93.80, the currency is trading at around 43.1% discount to the all-time high. This indicates that the currency still has more room to run.

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