The euro strengthened against the US dollar in the fourth quarter of 2020. FX hedging flows and slight improvement in current account may explain the EUR strength, in the view of economists at HSBC who expect EUR/USD to increase this year, but if old relationships are rekindled, it may weigh on the shared currency.
“Over the past couple of years, EUR/USD movements have been much more closely associated with ‘other investment’ flows, instead of portfolio investment flows. FX hedging flows have become more important and could remain so for the foreseeable future, possibly due to lower hedging costs, given that the Federal Reserve has cut its policy rate and remains persistently dovish under its new average inflation targeting framework.”
“There was also a modest improvement in the Eurozone’s current account surplus in late 2020, mostly due to the stabilisation of Eurozone exports compared to the more persistent decline in imports. It may have helped to explain some of the EUR’s rise late last year.”
“The EUR is likely to grind higher against a weaker USD in 2021, given that US monetary conditions will remain loose and risk appetite will remain more supported. Yet, if US short-term interest rates start to move more, or longer-term yield differentials become much more sizable, we might see a more persistent rebound in the USD.”