Broadly speaking, the risk is that the dollar’s cyclical advance is not complete. The drivers will likely remain in place through at least the middle of next year. Additional gradual interest rate hikes by the Federal Reserve and a favorable policy mix underpin the dollar. The Federal Reserve projects four rate hikes between now and the end of next year. Quarterly rate hikes through the middle of next year are the odds-on most likely scenario. By the middle of the year, the fiscal stimulus would have run its course, the accumulation of late-cycle behavior, warns the economy may begin slowing. A Fed pause in Q3 seems reasonable, which would suggest the removal of a headwind for the lira in H2 19. 

The forces of divergence will also likely keep the dollar’s uptrend against the euro intact through the first half of 2019. The ECB has indicated it will not raise rates until after next summer. The most recent data has been disappointing. Although the ECB will end its asset purchases this year, officials still believe extraordinary monetary policy is needed. It is possible that before raising rates, the ECB offers another Targeted Long-Term Repo Operation, which would have the effect of lengthening duration on the ECB’s balance sheets. 

Europe faces three distinct challenges besides the economy. Italy is challenging the EU’s fiscal rules. It will likely be on-going pitch battle. Although a divorce agreement between the EU and UK is the most likely scenario, the risk of that no deal is struck is substantial. S&P warned that the failure to reach an agreement could push the UK into a recession. Also, it would be a negative knock on the EMU. European political officials are weak. Merkel is seen as a lame duck now that she has indicated she will no longer be the leader of the CDU. She wants to complete her term as Chancellor but ultimately is do not seem particularly likely. France’s Macron is nearly as unpopular as Hollande. Italy’s prime minister is overshadowed by his two deputies who head up the coalition partners. Spain has a minority government. There are European Parliament elections at the end of Q2 19.