Introduction
For the longest time, the US dollar has been widely regarded as a safe-haven currency. This was by far attributed to the steady economic and labour market in the US and the pragmatic interest rate policies by the FED. Traders and investors could always fall back on USD when uncertainty gripped the rest of the world. While there is more on currency strength, demand for the dollar and dollar-denominated securities has tremendously surged in times of global crises.
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This has always been accompanied by an increase in its valuation in the forex market – as was the case during the onset of the COVID-19 pandemic. That’s because the US economy has been expected to have an advantage over the rest of the world. Even in times of crisis, it’s been expected to recover swiftly and almost effortlessly.
However, as the pandemic ravaged socio-economic stability, cracks began to appear. The subsequent aggressive monetary and fiscal expansionary policies further revealed the susceptibility of the USD to inflation. The FED cut interest rates from 1.75% to historic lows of 0.25%, while the government embarked on economic stimulus worth trillions. Naturally, out of fear of inflation, investors started looking for alternative investments, with cryptos emerging as the biggest beneficiaries.
US Dollar 2021: Time of Reckoning
Over the past four years, the USD has been the centre of global attention thanks to the wave of protectionist measures put in place. While they were meant to encourage the growth of the US economy, the trade wars with China and the EU did not help the valuation of the USD. Their long-term impact is just beginning to be felt.
Couple this with the economic devastation inflicted by COVID-19, the long-term outlook for the USD is bleak. Although the unemployment level has dropped from the historic highs of 14.7% in May 2020 to the current 6%, the economy is yet to return to its pre-pandemic capacity.
USD 2021 Current State
In the 2021 year to date, the USD has gained about 1.3% against major currencies as measured by the US Dollar Index (DXY). This can largely be attributed to the widespread increase in COVID-19 vaccination and the $1.9 trillion stimulus package.
Although Goldman Sachs estimates that the US economy will grow by at least 7.2% in 2021 compared to the 3.5% contraction in 2020, inflation remains a sore point for the USD.
Barely three weeks into April, the DXY has dropped about 2.8%. The sharpest monthly decline since November 2020. The USD has also weakened about 3.1% against the Euro during the same period, from 1.17 on April 1 to 1.20 on April 20. This means that the USD has shed more than half of the 5.36% gains it made against the EUR from January to March. Similarly, in under three weeks, the DXY has pared over 62% of the gains it made from January to April.
USD 2021 Outlook
In the current age of geopolitical uncertainties and coronavirus, one might argue that it isn’t prudent to forecast. While it might be true to say with absolute certainty how the USD will fair, the consensus is, its performance won’t be so good.
The optimism from the COVID-19 vaccine seems to be dying off. Not because of its efficacy but because global vaccination has been rolled out globally, somewhat successfully. This means that the US has no leg-up over the rest of the world. As other economies open up and gear towards full capacity, it means that the investors who had fled during the onset of the pandemic will start flooding back to riskier, high-return investments.
In the recent FOMC minutes, the US FED doesn’t envision any rate hikes in 2021. With the rates currently at 0.25%, investors are bound to return to the developing markets for higher returns on riskier investments. And as the economic confidence rebounds globally, the biggest loser will be the USD. In the short term, Morgan Stanley analysts expect that the USD will drop a further 3.9% against the EUR to close the year at 1.25.
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