Fundamentals

The first weeks of 2021 have seen significant developments in the US growth outlook. Following the Democrat victories in the Georgia Senate races, expectations for growth over the next 12 months have been revised up by around 2% to around 6% year-on-year. The key focus for the market is now the extent of the fiscal package delivered by the new administration, widely expected to be significant. Also, while Covid infections are higher than in Europe, the US has not locked down to the same extent, meaning higher levels of economic activity. These factors could precipitate a period of US exceptionalism, especially if the US vaccine rollout continues to outpace other countries. The resulting curve steepening and higher yields are lending the US dollar some support, challenging the consensus negative view. Ultimately, however, underlying currency fundamentals are weak. The dollar’s primary currency reserve status continues to degrade, as evidenced by the decline in the dollar’s allocation to the International Monetary Fund’s Currency Composition of Official Foreign Exchange Reserves (COFER) data. At the same time, the US trade deficit hit a new record in November, while further fiscal stimulus is now likely to widen the US current account deficit.

Growth forecasts are increasing, led by the US, given expected fiscal stimulus

Source: JPMorgan Chase & Co. Data as of 8 January 2021.

Quantitative valuations

The relatively strong US growth backdrop has led to higher US yields, with the 10-year Treasury yield rising 19 basis points in 2021 so far to 1.1%. At the same time, the US dollar has broadly gained strength, with the trade-weighted dollar gaining 0.4% year-to-date. Having fallen by 12% in 2020 from its peak in March, this recent strength represents something of a reversal. However, the story is not universal. The US dollar has continued to underperform against more pro-cyclical currencies, having lost 1.4% against the Norwegian krona and 0.9% against the Australian dollar year-to-date. The dollar’s yield advantage over much of the G10 is also not a factor when it comes to emerging market currencies, where absolute yield levels remain attractive. All these factors make it difficult to generalise about the future dollar’s future direction. (All data as of 13 January 2020).

Technicals

One potential near-term supporting factor for the dollar is that short positioning appears to be the consensus. Based on data from the Commodity Futures Trading Commission (CFTC) and our own positioning surveys, the evidence points to the market being both underweight the US dollar and overweight the euro. Our own indicator also suggests that long positioning in emerging market currencies is at levels not seen since early 2018. The positioning data presents the risk of a short-term reversal and should be noted.