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Wealth Insights Podcast 7

May 2021

Will the US Dollar remain under pressure in 2021?

Tommy Xie,
Head, Greater China Research,
OCBC Bank

The consensus for 2021 was a weaker US Dollar, due to a combination of factors including but not limited to a dovish Federal Reserve. A risk-on market environment was expected to cap the greenback’s strength.

Confirmation of a Democratic sweep in the 2020 US elections buoyed equity markets, as underlying market sentiment improved significantly on hopes of a vaccine progress and supportive global monetary and fiscal policies.

The US Dollar did not get the memo

However, the US Dollar is not playing according to script, as for the most part of this year, the US Dollar downtrend has stalled.

As the greenback rebounded in the first quarter of 2021, thanks to rising US Treasury yields, it paired with a stronger growth outlook to heighten inflation fears. The growth differential story resurfaced to dominate the FX market, as the US is expected to join China to lift the global growth to 6% in 2021.

The IMF raised the US’ growth by 1.3% to 6.4% in early April, citing three reasons, including the support from Biden administration’s US$1.9 trillion coronavirus package, accelerated vaccination rollout and the continued adaptation of economic activity to deal with the pandemic.

Stronger greenback in 2Q2021

We expect market optimism over a stronger US Dollar to remain intact in the second quarter of this year for two reasons: better US growth prospects and favourable yield differentials.

First, the growth differential theme is likely to stay, as the US Dollar benefits from the faster than expected vaccine rollout. We expect the US to achieve its vaccine induced herd immunity by this summer, which will further underpin healthy US Dollar prospect in the near term.

Second, the correction in US Treasury yields in the first half of April – despite booming US growth data – surprised the market, leading to a retreat in the US Dollar’s strength. However, our house view remains for higher back-end US Treasury yields, as inflation expectations is likely to have more room to drift higher over time. This should continue to exert upward pulling pressure on the US Dollar this quarter.

A different story for 2H2021

Looking ahead, our cyclically and structurally negative view on the US Dollar remains unchanged for the latter part of 2021.

Cyclically, optimism over European growth is likely to gain ground along the way. There is growing evidence that the European Union’s vaccination programme may be back on track after an initial delay.

We expect the growth normalisation theme will come back in the second half of the year. The synchronised recovery hope may eventually start to weigh on the prospect of the US Dollar, which is also seen as a safe haven bet.

Structurally, the twin deficits in the US, a decline in the US Dollar’s share of global FX reserves, the Federal Reserve’s commitment to keep real interest rate low for several years and potential higher taxes on corporate profit are negatives for the medium-term prospect of the US Dollar.

For 2021, although we remain constructive on Renminbi (RMB) outlook, we also note that positive drivers – including relatively faster recovery and elevated yield differential – have faded since the Chinese New Year after Chinese policymakers shifted their focus to managing tail risks.

The recent rise in volatility in China’s financial market, associated with regulatory actions in the technology and financial sectors, may limit the upside of RMB. In addition, the RMB’s appreciation has also been pushed back against the backdrop of still high US-China tensions.

Commodity currencies will be our top picks as winners in 2021, as currencies that may do well against the US Dollar. With Europe’s reopening expected to be back on track soon, and more infrastructure investment plans being rolled out in the US, a broader global recovery will be the catalyst for more commodity upside, which will further underpin oil prices and copper prices.

Among these currencies, we like the Canadian Dollar (CAD) the most and expect CAD to outperform in 2021 on the back of higher oil prices and earlier removal of easing monetary policy.

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