The news of coronavirus vaccines sent stocks higher and the safe-haven dollar lower. Alongside decisive US elections and later some fiscal stimulus, there was no need to run for shelter, and the dollar suffered. The consensus trade is that the late 2020 trend is a friend – an extended greenback grind in 2021. Yohay Elam, an Analyst at FXStreet, lays out five factors that may add fuel to the fire or potentially calm it and extinguish it.
Key quotes
“Contrary to reactions in the UK and the eurozone, printing greenbacks has resulted in a straightforward devaluation of the dollar. With the pedal to the metal, further falls are likely. However, nothing lasts forever, and that includes the bank’s rates and QE commitments. The bank would even welcome signs of price rises – reflecting a growing economy and also compensating for subdued inflation in previous years. To battle rising inflation, the Fed could raise rates – boosting the dollar. The Federal Reserve is unlikely to hike interest rates at first sight of inflation, but it may signal that it would withdraw bond-buying or move rates higher in 2022. Any indication that loose monetary policy is tightening would spook markets and already caused a reversal of the overextended greenback grind.”
“The pace of vaccinations is set to accelerate and bring the world back to normal, boosting sentiment and weighing on the dollar. However, there is a downside potential as well. Covid, like any virus, can mutate and become resistant to the jabs, forcing researchers to go back to the labs and remake their inoculations. Any delay in resolving medical issues would slow the recovery. In that scenario of a constant struggle between scientists and the virus, 2021 would not be the end of the virus, and investors would flee to the safety of the dollar.”
“Biden and Democrats will be unable to enact sweeping reforms but probably add between $1 or $2 trillion to government spending. Apart from aid to states and the unemployed, they could lift America’s often-crumbling infrastructure – another boost to the economy. In that outcome, the dollar would suffer. The flipside is that the GOP returns to sabotaging the economy as it did when Biden was Vice-President. If McConnell refuses to bring any suggestion to the Senate floor, recovery in both the US and the world would slow down, boosting the greenback.”
“The new president touted his working-class credentials on the campaign trail and will likely attempt to revive American manufacturing. Will the US and China accelerate their decoupling? These massive economies still depend heavily on each other, and the occasional soothing of tensions would weigh on the greenback. Nevertheless, unless the rules of commerce are re-established – under a reformed World Trade Organization (WTO) – Sino-American tensions will probably be a positive factor for the dollar in 2021.”
“Instead of a sell-off, every expansion of the ECB’s Pandemic Emergency Purchase Program (PEPP) boosted the euro. The new narrative is that the funds allow governments to support the economies and thus strengthen the currency. At least in the early part of 2021, this phenomenon may continue in full force, boosting the single currency and pushing the euro higher at the expense of the dollar. However, the latter half of the year may see a change. The ECB could signal that it is letting its program lapse in early 2022 as planned, thus weighing on the currency and supporting the dollar. Moreover, the bank may further cut its deposit rate below -0.50% – a move that would depress the currency.”
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