The mighty US dollar, the world’s reserve currency and a safe port in an economic storm, has had a rough ride in recent months.
The greenback performed its traditional role as a global safe haven during the stock market meltdown in March, when investors rushed to buy dollars and sent its value soaring relative to lesser currencies.
Now, the opposite is happening. As Covid-19 vaccine success triggers hopes of a post-pandemic recovery and investor confidence rebounds, the dollar is falling in value. The dollar has done its job as a shock absorber, but investors are now looking elsewhere for higher returns.
This is bad news for UAE-based expats and residents, as the value of their US dollar-linked dirhams are falling in lockstep, relative to other currencies.
Many will have taken the strong dollar for granted and are shocked by its recent reversal. So, what does 2021 have in store?
How has the dollar crashed?
Currency specialists measure the greenback’s relative value by comparing it with a basket of foreign currencies, using the US Dollar Index .
At the time of writing, the index stands at about 90.80, which means the dollar has fallen more than 10 per cent since its March peak, when it surged towards the 102 mark. Measured over one year, it has fallen 6.60 per cent.
Arun Leslie John, chief market analyst at Century Financial, says this is a major drop in currency terms and many in the UAE will be feeling the pain. “Overseas holidays, property, investments and remittances are all more expensive now, with the obvious exception of the US.”
The dollar decline set in after March 23, which is when the US Federal Reserve bailed out global stock and bond markets by flooding them with liquidity and unleashing a multitrillion-dollar programme of monetary stimulus.
The Fed’s balance sheet ballooned from $4.31 trillion on March 15 to $7.24tn by November 17, and this flood of newly minted dollars is a key reason for the currency’s slide in value.
Mr Leslie John also pins it on a major policy shift announced by Fed chair Jerome Powell in August, which allows inflation to run hotter than normal to support the labour market and broader economy.
If inflation picks up but the Fed does not respond by raising interest rates as it normally would, international investors in US bonds could end up with negative yields in real terms. This is bearish for the dollar because they are likely to respond by dumping US dollar holdings and investing in countries with higher yields.
Mr Leslie John adds: “A string of US government fiscal stimulus packages have also added to the dollar’s slide.”
Democratic Party leader Joe Biden’s election victory signalled continuing further loose fiscal and monetary policy, including a possible $908 billion relief package, and this has put added pressure on the dollar.
When Pfizer and BioNTech announced successful Covid-19 vaccine trials on November 9, the dollar fell again as investors anticipated brighter days for stock markets.
That may sound counterintuitive, but newly confident investors are targeting emerging markets that look set to generate a higher return than the US.
Mr Leslie John says economists now expect the global economy to recover to pre-pandemic levels by the second half of 2021. “Once again, this has dented the safe-haven demand for the dollar.”
Where does the dollar go next?
Gaurav Kashyap, head of futures at Equiti Global Markets in Dubai, says the greenback may enjoy a short-term bounce in 2021 after recent “torrid” months, but this is unlikely to prove sustainable.
Markets are eagerly awaiting the US government’s relief package in early January. “Once this materialises, the focus will shift back to the Fed, which I expect to extend its quantitative easing programme. This unprecedented easing does not favour the dollar in the longer run.”
Mr Kashyap says the US Dollar Index could fall as low as 88.20 during the second quarter, a drop of a further 3 per cent from today.
Mr Leslie John also sees the dollar falling to around the 88 mark. “If it drops below that, it could fall to around 86.5.”
Both analysts see little potential upside, saying the dollar would meet strong resistance around the 92 mark.
John Hardy, head of FX strategy at Saxo Bank, says a weaker US dollar in 2021 is very much a consensus trade. “A weaker US dollar seems likely, provided we see a solid vaccine effort that boosts global growth, with inflation rising but not too quickly.”
If the US economy recovers quickly and inflation accelerates, the dollar could recover in the second or third quarter and today’s negativity will look overdone. “It’s not a simple ‘everything up and US dollar down’ outlook for the year,” he adds.
How will the dollar fare against other currencies?
Currencies do not perform badly or well in absolute terms, but only in relation to rival currencies.
Mr Hardy says the US dollar is likely to struggle against currencies from major commodity producing countries, which should strengthen as demand for natural resources increases.
In that scenario, the Australian dollar, New Zealand dollar and Canadian loonie, and emerging market currencies such as the Russian ruble and Brazilian real, would beat the dollar in 2021. “The dollar won’t really do well against anything, except perhaps the British pound and Japanese yen,” Mr Hardy says.
Commodity exporters will enjoy an extra lift from rising China, whose gross domestic product seems likely to grow by around 5 per cent in the fourth quarter as it posts the largest trade surplus in its history, Mr Leslie John says.
Chinese 10-year yields are currently at 3.29 per cent, making the country attractive to overseas investors. “As the Chinese yuan rallies, it could pull up other currencies relative to the dollar, such as the Indian rupee, South Korean won and New Taiwan dollar.”
While the US dollar has crashed, the euro has flown. In March, it traded as low as $1.07, but today it buys about $1.22, a hefty 14 per cent rise.
Mr Leslie John says the eurozone has a current account surplus, while the US has a deficit and Fed stimulus will worsen the trade balance. Both factors will work in favour of continued euro strength.
If the analysts are correct, 2021 looks set to bring yet more bad news for UAE expats and residents sending money to pretty much every country in the world, except the UK (depending on Brexit).
Predicting future currency movements with any degree of accuracy is hard, and the dollar could still spring a positive surprise in 2021.
For those sending money overseas, timing currency movements is a hopeless task. Hanging around for a favourable rate can backfire, because the exchange rate could get even worse before it gets better.
What is the impact on US shares?
For investors, there is one benefit to a weak US dollar. It could help to drive up US share prices. Fawad Razaqzada, market analyst with ThinkMarkets, says the US economy added 245,000 non-farm jobs in November, much weaker than the 480,000 expected, as lockdowns hit the labour market.
This means the Fed will be in no hurry to start tapering QE when vaccines are rolled out. “This should benefit the dollar bears and the stock market bulls. So, don’t be surprised if the S&P 500 hits new highs, even as the dollar falls.”
The US dollar might not look so mighty at the moment, but its stock market still does.