Dollar and the three bears

The US Dollar Nominal Effective Exchange Rate (NEER) traded in a narrow range of 1.8% between late-2020 and early March, according to our estimates. The Dollar then embarked on a 3–4 week rally, driven by rising US Treasury yields, the stretched valuations of other major currencies and still tepid global economic activity.

Since end-March the Dollar NEER has depreciated 1.8% to a 7-week low. Stronger US economic growth — fuelled in part by the government’s $1.9 trn coronavirus relief package — alongside lower US yields across the maturity spectrum and rising US and global equities have weighed on the “safe-haven” Dollar’s relative attractiveness.

Global FX volatility has remained subdued and well below its 10-year average. However, the performance of major currencies has, unlike in November-December, been far from even.

In particular, Non-Japan Asian currencies have underperformed which we attribute in part to NJA central banks’ more pro-active management of their currencies.

This timeline, its drivers and the relative performance of the Dollar and major currencies, including in the emerging market space, have been in line with our expectations (see Forecast review: USD, CNY, EM & global growth, 21st December 2020, Dollar — Diversification, rotation and valuations, 18th January 2021, Dollar’s recent weakness — Blip, not new trend, 12th February 2021 and US and UK: The Comeback Kids, 5th March 2021).

Further US Dollar depreciation in weeks ahead, in our view, remains conditional on both:

i) The ability of a dovish Federal Reserve and FOMC members to further jawbone lower or at the very least cap US Treasury yields; and

ii) Global macro indicators continuing to point to a pick-up in economic growth.

Our core scenario is that the Dollar will indeed lose further ground but that the performance of other major currencies will be conditioned by powerful, often inter-related domestic factors and thus remain far from uniform.

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