Analysts at Bank of America Merrill Lynch express bullish views on the U.S. dollar for the year, though they anticipate that a correction to the USD rally will present a buying opportunity early this year. Athanasios Vamvakidis and Arko Sen also said in their January 11 research piece titled “2017: the 51 weeks ahead” that they believe if the ratings agencies affirm their ratings on January 13, the Polish zloty will be well-positioned for recovery.

U.S. and Europe could witness tail risks

Tracing the market volatility over the past year, Vamvakidis and Sen point out that about a year ago, the markets were panicking about deflation, following the oil prices and the RMB’s devaluation. However, in their recent report, they explain how their contrarian view that “inflation would surprise markets” has played out.

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They highlight that last year, the good case inflation scenario got unfolded and market conditions improved. For instance, commodity prices bottomed out and inflation in major economies started rising:

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The BofAML analysts recall their predictions as to how the Republicans’ sweep in the U.S. elections would lead to fiscal stimulus and a bullish stance for the U.S. dollar. They point out that within hours of the U.S. election results being released, the markets started pricing in fiscal stimulus, presenting an opportunity to the Fed to prepare the markets for a sharper pace of hikes. The analysts highlight that in their year-ahead report, they reiterated their bullish USD view, though nearly 80% of the moves they were anticipating by the end of 2017 have already happened.

In the above context, the analysts present both positive and negative scenarios for the U.S. dollar. Despite their bullish view on the USD, the analysts express concern about substantial tail risks in both the U.S. and Europe that could trigger market volatility.

U.S. Dollar – 10y UST yield could ratchet to 2.65 by end of 2017: BofAML

Vamvakidis and Sen believe the next U.S. administration could deliver a sizable fiscal stimulus and China could remain on a soft landing scenario, with oil stabilizing around the current sweet spot. The BofAML analysts believe in such a positive scenario, the USD will remain strong. Citing their equilibrium estimates, the analysts argue that despite the USD being overvalued by 15%, it’s still below the peak of 22% overvaluation in 2002. They envision the USD/JPY at 120 and EUR/USD at 1.02 in 2017:

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US Dollar

Highlighting their bad-case scenario for the U.S. dollar, the BofAML analysts believe weak U.S. data in Q1 could be a setback for the USD, though such a correction would eventually present a buying opportunity for the USD.

The BofAML analysts predict that the EUR will trough at 1.2 by mid-year and the 10y UST will touch 2.65 by year-end with upside risks.