Exhibit 72: Trade-Weighted US Dollar Index The recent dollar rally implies much of the good news has already been priced in.
January 1997 = 100 1
40 5
30
10
90 4
80
1995 2000 2005 2010 2015
Data through December 31, 2016. Note: Shaded areas denote periods of US recession. Source: Investment Strategy Group, Datastream.
-g J 2011
Exhibit 73: Eurozone Net Portfolio Flows Policy divergences could continue to drive portfolio investment out of the Eurozone.
2-Month Rolling Sum, % of GDP @ 5
Capital Into Eurozone = Euro Appreciation
f
Capital Out of Eurozone = Euro Depreciation MEE Net Equity | Net Debt Net Portfolio Flows
2012 2013 2014 2015 2016
Data through October 31, 2016. Note: 03 2016 data used to calculate 04 2016 share of GDP. Source: Investment Strategy Group, Haver Analytics.
partly reflected in current exchange rates, the US dollar is vulnerable to both domestic and foreign disappointments.
In sum, we expect the dollar to appreciate further, but at a slower pace and with greater volatility than in recent years.
Euro
The euro was on the losing side of the US
dollar’s strength again in 2016, marking the third consecutive year of underperformance and the longest stretch of annual declines since 2001. Last year’s modest 3.2% decline actually masked a much larger 10% drop from the euro’s intra-year peak, half of which came in the weeks following the US elections in November. Needless to say, the combination of potentially expansionary fiscal policy put in place by the new administration coupled with tighter US monetary policy represents a stiff headwind to the euro, particularly since
We should not lose sight of the fact that after such persistent weakness versus the US dollar, the euro is undervalued and investors are now positioned for further weakness.
the ECB just extended quantitative easing until December 2017.
We expect these transatlantic policy divergences
to persist, driving European investors to continue seeking higher-yielding, non-euro-denominated assets abroad (see Exhibit 73). This preference
will likely be bolstered by uncertainty surrounding upcoming national elections in Germany, France, the Netherlands and possibly Italy and Spain. While our central case assumes mainstream parties prevail, any result that raises questions about the long-term viability of the European Monetary
Union could push the euro even lower.
Still, we should not lose sight of the fact that after such persistent weakness versus the US dollar, the euro is undervalued and investors are now positioned for further weakness. Additionally, the above-trend Eurozone growth and normalizing inflation we expect could justify the ECB shifting toward a more neutral stance later this year.
Such a move would narrow the interest rate differential between the US and Eurozone, weakening a linchpin of the weaker euro thesis.
Given this balance of risks, we removed our tactical short positions in the euro relative to the dollar following the November US presidential election, returning to a neutral view.
62 | Goldman Sachs | JANUARY 2017
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