What’s in store for the US dollar in 2021? – Xe

What’s in store for the US dollar in 2021?

 An Article by Ron Vodicka – Senior Corporate Dealer, Xe

In the opening weeks of 2021, the US dollar has seen a bout of strength. But how will the value of the dollar fare in the coming months? In our forecast, we’ll tell you what we think.

At this time, the onset of 2021 has brought a bout of US dollar (USD) strength. The USD Index has risen 2.2% from its 34-month low set on January 6th. This recent strength is a major contrast with the -15% performance the USD experienced over the prior nine months.

USD at a glance

What’s impacting the dollar right now?
• Unemployment fell to 6.3% today from 6.7% last month.
• The US Treasury bond yield curve is upward sloping and at higher interest rate levels, pointing toward a continued recovery.
• The IMF, Goldman Sachs and other large investment firms are calling for a boom 2nd half to 2021.
• COVID-19 cases have fallen dramatically in the US this week, and Johnson & Johnson is about to announce their vaccine.

These data points all hint towards positive US economic growth as 2021 continues.

Given the new U.S. presidential administration and the development of COVID-19 vaccinations, market participants are wondering what’s in store for the USD in 2021. To answer this question, it’s important to first review the dollar’s recent history.

The US dollar in review

From 2011 to early 2020, the dollar appreciated nearly +28% as global investors flocked to the US markets to buy US assets and participate in the booming US economy. This dollar uptrend held despite then-President Trump’s efforts to talk down the dollar, as higher US treasury yields and continued equity market returns kept the dollar firm.

Then COVID-19 struck in March 2020, changing everything.

The dollar initially sank in sympathy as global equity markets began to unravel. However, once the magnitude of COVID-19’s economic impact became more apparent, a new market “risk aversion” theme took hold.

Investors quickly bailed on risky assets and flocked to USD-denominated “safe-haven” assets en masse, believing they would be more likely to maintain their value and hold steady even as financial markets crumbled.

In just two weeks, this mad dash into safe-haven USD assets spiked the USD Index +7.5% and left the USD with an artificial “risk aversion” premium built into its value from its perceived low uncertainty.

It has been this risk-aversion premium that then most influenced the USD’s 2020 USD trading. For the prior nine years, traders had bought USD on good investor news to invest in US assets In the new COVID-19 world, traders did the opposite, selling USD on good market news.

Why? Because traders were already overweight US assets and even more so with the newly purchased safe haven assets. So, as 2020 unfolded and the investment climate improved due to central bank and government actions, the need for safe-haven assets diminished and traders began unwinding these positions.

And, with this, the negative equity market correlation was born, and flipped risk-on and risk-off its head.

Ordinarily, the value of USD assets would rise in conjunction with increased market optimism (risk-on), and uncertainty or negativity would drive investors to sell their riskier assets in favor of safer ones (risk-off). Good news for investors would mean good news for the dollar, and the same with bad news.

Now, good news for investors was bad news for the dollar, and bad news for investors was good news for the dollar. Economic fundamentals didn’t matter.

This theme held strong for the remainder of 2020. If US stocks went up (and they did!), then the USD would fall (and it did!). It was virtually guaranteed.

What’s going to happen in 2021?

To answer that question, we’ll need to consider two key questions.
1. Will 2021 be a continuation of 2020’s risk-aversion trading theme?
2. Will traders conclude that the USD risk-aversion premium has been wiped out and it is time to start trading off market fundamentals?

Up until this week, 2021 FX trading was looking just like 2020. Post-US election equity markets surged on the elimination of election risk, positive vaccine news and the idea of a large US fiscal stimulus package. Unsurprisingly, the USD fell -6%. And on January 6th, after the storming of the US Capitol, when uncertainty was reintroduced to the markets, the USD rose 2%.

So, what will it be for the dollar going forward? It depends on whether or not you believe the risk-aversion trading scenario will continue.

• If you do believe this, then you likely believe the US dollar will continue to depreciate as global equity markets continue to move higher.
• If you don’t believe this, then you believe the worst of the pandemic is over, traders have priced out the “risk-aversion premium” to the dollar, and that the USD will trade on fundamentals again—meaning good economic data and continued equity market returns will strengthen the USD.

In conclusion?

Should 2020’s risk-on and risk-off trend reverse, we will see a strong US dollar. The IMF recently raised the US’s 2021 GDP forecast to 5.1% from 3.1%, which was an outlier to the EU.

Additional vaccines coming onto the market could boost confidence, as would an additional fiscal stimulus package. The US could see unleashed economic growth in the second half of 2020, continuing to draw global capital. Additionally, some currency moves may have gone too far, and natural flows will come back to the USD and US markets.

If February’s first week of trading is any indication, it looks like 2020’s negative correlation has broken as both the dollar and equity markets rallied in sync.

Stay ready for market motion with Xe

Markets never move linearly. There are always gyrations. So, whether you’re a dollar bull or bear, whether you need to buy or sell dollars, you will get your opportunity. Be prepared, know your position and be ready to act when the market opportunity presents itself.

Xe is here to help you to monitor the currency markets and minimize the impact of volatility. Sign up for an Xe account, or contact Anjulie on +44 7384 113 495 / Anjulie.Patel@xe.com to discuss your business’ requirements in more detail.

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