With the US midterm elections over and the results broadly expected, attention turns to how the US economy will perform with a split Congress and what the Federal Reserve will do next.
It is unlikely President Trump will be able to implement a second round of tax cuts in 2019. Instead, focus may shift to infrastructure spending in order to keep the economy moving. Given deep divisions between both parties, consensus on any proposals will be difficult to reach with the economy likely to slow progressively in 2019 as the tax cuts start to lose its effectiveness. In the short-term, US growth is likely to remain strong compared to the Eurozone area thereby keeping the US dollar stronger.
Despite the election results, the Trump Administration is likely to keep the US-China trade dispute high on its agenda. As a result, further tensions are likely between both countries which should result in higher demand for safe-haven currencies, particularly the US dollar which we expect to remain strong in the short-term.
Federal Reserve – not loco.
A gradual increase in interest rates is reasonable as the US economy strengthens and it is unlikely Fed policy will be substantively altered in the near term by the election results. With a strong US labour market, we expect another quarter percent rate hike in December resulting in a stronger US dollar.
Overall, over the next three months, we expect the US dollar to remain strong based on stronger US economic growth, higher interest rates and safe-haven currency demand on continuing trade tensions. As a result, our three-month forecast for EURUSD is 1.10. However, with fiscal stimulus likely to recede in 2019 along with potential negative effects of tariffs leading to slower US economic growth; the Fed becoming less likely to raise rates, and the ever-mounting US twin fiscal and trade deficits should put downward pressure on the dollar over the longer term. Therefore, our twelve-month EURUSD forecast remains at 1.20.
EURUSD is currently trading at new 2018 lows on Italy’s political turmoil as the government continues to tweak its budget and prepares to battle with the European Commission.