Dollar weakness remains entrenched

Dollar weakness remains the short-term narrative for currency markets as the variables that contributed to a sagging greenback in 2020—an aggressive expansion of Covid-19 cases, political uncertainty surrounding elections and policymaking and a lagging fiscal response to the pandemic’s economic impact—remain largely intact. We had projected a softer dollar against major peers for 2021 but many of our targets have actually already been exceeded as the market accelerated its sell-off of dollars over the last few weeks. With that in mind, we are marking several of our forecasts to market and adjusting our forex views accordingly.

Rates not in driving seat

After central banks pulled their policy levers hard in 2020 to offset the damage wrought by the Covid-19 pandemic, interest rate policies are unlikely to have as substantive an impact on currency markets this year. All major central banks have brought their policy rates close to or below zero and swaps markets show no deviation from those levels: 1Y1Y swaps for all major currencies show no substantive movement as markets expect policy makers to keep rates anchored at their current low levels (the RBNZ may the sole exception as the bank has seemingly walked back from planning to use negative rates).

Forward swaps show little movement (1Y1Y swaps)

Source: Bloomberg, Emirates NBD Research

Growth and inflation projections will thus be a much more meaningful indicator for the trajectory of currency markets in 2021. Consensus expectations are for the US to be a relative underperformer compared with major peers such as the Eurozone, UK or Canada with GDP growth of around 3.9% for 2021. Part of the lagging performance will be related to the high incidence of Covid-19 in the country—with around 65k per 1m population, the US has among the highest prevalence among major economies and is worse than the 41k per 1m population in the UK and 22k per 1m population in Germany. The deployment of Covid-19 vaccines is a welcome development for getting economies back to ‘normal’ pre-pandemic conditions but will still take time to rollout and given how politicized the issue of the virus became in the US, getting the population to actually take a vaccine may prove an additional challenge.

Consensus expects US to underperform on growth

Source: Bloomberg, Emirates NBD Research

Politics still matters

With only a few weeks before Joe Biden is inaugurated as president of the US, currency markets could be forgiven for thinking that political risk in the US should be classified as a 2020 issue only. The tight US Senate runoff votes in the state of Georgia highlight just how narrow the Democrats margin of victory has become. While Democrats may gain control of the Senate via Vice-President-elect Kamala Harris’ tie-breaking vote, they won’t have enough votes to prevent filibusters from the Republicans from delaying or derailing some of Biden’s more ambitious policy objectives. Hence, we are still a little circumspect about how much meaningful fiscal stimulus will hit the US economy this year—the USD 900bn package agreed over the holiday period at the end of 2020 incorporated mostly funds that had already been allocated for the CARES relief package agreed earlier in the year, rather than new spending.

Fiscal repsonses to Covid-19 (% of GDP)

Source: IMF, Emirates NBD Research

Risk on, dollar off

The dollar is also functioning as an expression of risk-on/risk-off sentiment in the market. As positive news or surprises hit the market—such as a successful Covid-19 vaccine candidate or better than expected data—the dollar has given way to rallies in risk assets or more risk-oriented currencies. We don’t expect much in the short-term as far as positive vaccine surprises given that several firms have had their candidate drugs approved for use and are already being deployed. However, as markets grow more confident in the spread of the vaccines globally they may choose to express that in short-dollar positions. Indeed, DXY futures and options positioning is already significantly net short on the dollar.

Short dollar trades dominate futures and options markets

Source: Bloomberg, Emirates NBD Research

Our expectation then is for another year of broad dollar weakness although not as sharp as 2020’s performance. Most of the upward moves in currencies will be grinds higher as each country grapples with their recovery at their own pace, with pitfalls highly likely along the way. Nevertheless, the weight of markets is pushing solidly against the greenback at this stage and policy and fundamentals are easing their way.

Source: Bloomberg, Emirates NBD Research.