Global currencies outlook: trends to watch in 2021

• We expect US monetary policy to remain highly accommodative in 2021, despite large-scale fiscal stimulus and an expected economic recovery starting later this year.

• Consequently, we expect only a limited appreciation of the dollar against other developed-market currencies in 2021. We forecast that the dollar will stand at US$1:€1.16 and ¥1:US$106 at the end of this year.

• Against a backdrop of recovering global demand and ample liquidity, many emerging-market currencies that depreciated significantly in 2020 will appreciate this year. However, currency markets will remain sensitive to local economic conditions, and demand will favour countries with comparatively rapid vaccination rollouts.

In the first few months of 2020 the US dollar index surged to an all-time high as the first wave of the coronavirus (Covid-19) pandemic prompted a flight to safety and a shortage of US dollar liquidity. The currencies that fell most were those of emerging markets and commodity exporters (including advanced economies, such as Australia, New Zealand, Canada and Norway) that experienced particularly sharp depreciations amid collapsing commodity prices.

The US dollar gave up most of these gains in the second quarter, when the Federal Reserve (Fed, the US central bank) injected about US$3trn of liquidity in financial markets and concerns that the pandemic would spark a financial crisis eased, reducing precautionary demand for dollars. The dollar depreciated further against the euro and other major currencies in the second half of the year as the Chinese economy reopened, the euro zone agreed to a concerted pandemic relief package, and the results of clinical trials showed that some coronavirus vaccines were effective. By the end-2020 the US dollar index had fallen by more than 5% compared with a year earlier; although still elevated by historical standards, it remains well below late 2019 levels, when its value was boosted by robust US growth and the protectionist policies adopted by Donald Trump, the former US president.

Continued Fed easing will limit the extent of dollar appreciation in 2021

The outlook for the US economy changed substantially when the Democratic Party won the Senate (upper house) elections in Georgia on January 5th, thereby gaining control of both houses of Congress and making large-scale fiscal stimulus more likely. Although a new pandemic relief package is likely to be smaller than the US$1.9trn initially announced by the president, Joe Biden, it will nonetheless be a significant addition to the US$900bn stimulus package already adopted by the Trump administration in December 2020. In addition, the US vaccination campaign is progressing faster than in most other countries, and we expect economic restrictions to ease relatively quickly, setting the scene for an economic recovery in the second half of the year. By contrast, in the euro zone social distancing and other containment measures are likely to remain in place into the third quarter.

Nonetheless, we expect the US dollar to appreciate only modestly (by less than 2%) against the euro, the yen and the renminbi in the second half of 2021. The reason for this is that the Fed is likely to accommodate fiscal stimulus with continued asset purchases, in line with its shift to a more expansionary monetary policy framework in August last year, which it reaffirmed in its communications in early 2021. At the Fed’s policy meeting in late January the chair, Jerome Powell, made it seem as if there were no conceivable circumstances under which the central bank would reduce its support to the economy this year. In Congressional hearings in late February Mr Powell largely dismissed concerns that the US would see a period of runaway inflation. We do not expect the Fed to taper its asset purchases (currently US$120bn each month) before end-2022, and the Federal Funds rate is likely to stay close to zero for even longer. This will in turn dampen any appetite to bid up the value of the dollar this year.

In the medium term, the US dollar could receive a stronger boost from the Biden administration’s ambitious infrastructure spending plans. For now, however, we continue to believe that these will need to be significantly scaled down, given the Democrats’ razor-thin majority in the Senate. Until prospects for the 2022 mid-term election become clearer, this limits the risk of a rapid dollar appreciation.

Many emerging-market currencies will appreciate this year

Receding risk aversion in global financial markets, rising prices for many commodities and continued monetary policy accommodation in advanced economies will support many emerging-market currencies in 2021 as investors search for higher yields. With some notable exceptions, including Brazil, Latin American currencies will broadly benefit from this trend, reversing some of the heavy losses recorded over the past year. We also expect emerging economies in central Europe to record appreciations of their currencies against the euro in real terms. However, some regional central banks would rather avoid excessive exchange-rate strength. The National Bank of Poland, for instance, has recently started to intervene in the currency market to prompt a depreciation of the zloty against the euro, but an expected robust economic recovery and a wide current-account surplus will probably force a modest appreciation against the euro in 2021. We also forecast a modest appreciation in the rouble as Russia benefits from rising oil prices and a rising current-account surplus.

Currency markets will remain mindful of country-specific risks

However, we also expect a number of exceptions to this trend. The renminbi and many other Asian currencies finished 2020 at higher levels against the US dollar than a year earlier, buoyed by the rapid bounce-back of economic activity in China and by the broad success of other economies in the region in containing the spread of the pandemic. Asian economies will benefit from a recovery in global trade volumes this year, and we expect a further strengthening in the Australian and New Zealand dollars as commodity prices continue to firm. However, given the sustained appreciations already recorded in 2020, we see less room for gains against the US dollar in 2021. We expect the renminbi to depreciate slightly in the second half of this year.

Many developing countries will also continue to face an uncertain outlook in the early stages of the post-pandemic recovery. Low-income countries will be unable to compete with advanced economies in the vaccination race, and will instead depend on assistance through the World Health Organisation (WHO)-led COVAX facility, which aims to ensure equitable access to vaccines. Developing countries will therefore remain vulnerable to new waves of the coronavirus pandemic throughout 2021, and will see limited benefits from investors’ search for yield. The risk of external funding gaps is also significant; in 2020 the IMF provided financial assistance to 85 countries, most of which are in Sub-Saharan Africa. The region has the weakest growth outlook in 2021, and an uncertain economic recovery is a significant balance-of-payments risk. For instance, we expect the South African rand to continue to depreciate against the US dollar in 2021. Although it will benefit from the global upturn and stronger commodity prices, it will remain under pressure from fiscal and current-account deficits and a slow rollout of vaccines.

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