In our last commentary on the US dollar, we wrote that the buck was set to move higher given underlying economic trends. Specifically, US growth and inflation was likely to keep accelerating, while the opposite was likely to happen in most major regions outside the United States. Following the publication of our last commentary, the US dollar index has strengthened from around 91.80 to around 95.20 today.

While economic trends are now changing, the US dollar is likely to keep strengthening. Going forward, we forecast a further slowdown in global growth and also expect US growth to begin decelerating in rate-of-change terms. Despite significant changes in the underlying landscape, the US dollar rally is just getting started.

The economic growth party is coming to an end

Following two years of accelerating GDP growth (the longest expansion in recent US history), the future outlook for US growth has darkened considerably. Specifically, growth is set to be weighed down by steepening base effects. That is, relatively high growth at this point last year makes year-over-year growth mathematically more difficult going forward. This is shown visually below:

Visualized: steepening base effects

Source: US BEA, MarketsNow

As can be seen above, year-over-year growth in the second half of 2018 will have to contend with relatively high growth rates in the second half of 2017. Beyond base effects, forward-looking economic indicators have also deteriorated in recent history. Recent economic data (e.g. ISM sentiment figures, retail sales, industrial production, etc.) have all softened over the past few weeks. Thanks to weakness in recent data combined with steepening base effects, year-over-year growth is more likely to slow in the near future.

Inflation outlook also darkening

As the outlook for growth darkens, the outlook for inflation is remarkably similar. The two factors weighing on the inflation outlook include (1) slowing commodity price growth and (2) steepening base effects. This is shown below: