Currencies
USD set to lose further ground
We expect further USD declines in 2021 on the back of improving global growth, a deteriorating US real yield advantage and the widening of fiscal and external deficits. The EUR and JPY should benefit from this trend. We believe the CNY will also gain, supported by portfolio flows.
So far this year, the USD has lost ground against other major developed market (DM) currencies. In the face of what we expect to be an ongoing global recovery in 2021, we think the USD should continue to lose ground. The very accommodative US Federal Reserve (Fed) has erased the USD’s interest rate (or carry) advantage, and the prospect of poor US fiscal and external balances should further weigh on the USD. The Fed’s adoption of a new policy framework, including average-inflation targeting, increases the risks of higher long-term inflation expectations. With the Fed unlikely to raise policy rates for the next 2-3 years, hence preventing sharp moves in nominal yields, US real yields risk moving even lower. This should further weigh on the USD. An extended second wave of COVID-19 infections over the winter months could, however, create some market volatility and enable the USD to gain ground temporarily due to its safe-haven status.
Rosier outlook for EUR
Political risks to the EUR have receded with the comprehensive European Union (EU) recovery fund. Despite some widening in the fiscal deficit, the EU’s structural external balances (3% surplus on average over the last five years) are sound and superior to those of the USA. Moreover, in a world of worsening public finances, we think that the new EU-wide bond creates a tool to promote EU convergence and should boost the availability of attractive safe liquid assets. This could also help the EUR. With EUR valuations still attractive, we expect EUR/ USD to reach 1.25 at the end of 2021.
JPY, GBP undervalued vs. USD
The JPY has an improved outlook as US interest rates converged with those of Japan and, in fact, turned even lower on a real basis. The JPY remains undervalued against the USD, while Japan’s structural current account surplus and strong international investment positions support the currency. We forecast a modest GBP appreciation next year, as uncertainty on the political and the monetary policy side should diminish and allow the market to refocus on the GBP’s cheap valuation, especially against the USD.
CHF likely to soften
Short-term uncertainties related to the geopolitical situation and COVID-19 may keep the CHF supported up to the end of 2020. Still, the Swiss National Bank is likely to prevent the CHF from appreciating by intervening in the foreign exchange market if needed. In 2021, we expect the CHF to depreciate modestly against the EUR thanks to the improved outlook for the global economy and the largely overvalued CHF.
EM currencies should gain ground
With the USD likely to extend its weakness, the fundamental outlook for emerging market (EM) currencies should improve in 2021. While we believe that economic activity in EM should remain subdued in the short term considering the residual effects of the COVID-19 shock and uncertainty about the need for additional measures to deal with the virus, we also expect the economic recovery in EM to slightly outperform the US in 2021. We would expect a lower degree of policy support as fiscal measures are partially reversed and EM central banks become less accommodative after inflation bottomed in Q3. As global interest rates remain persistently low, potential rate hikes in EM could give some support to EM currencies, as long as such hikes are not seen as undermining real activity. Against this backdrop, we would expect some degree of differentiation across currencies.
In Asia, China’s current account surpluses should decline and eventually turn into a deficit, with the economic rebalancing structurally favoring consumption and lower savings over the longer term. However, net portfolio flows should remain strong into 2021. China offers more attractive interest rates compared to global core bond yields, while equity flows may also be positive given the recovery of China’s economy and the associated path of earnings growth. All in all, we anticipate some CNY appreciation next year and forecast USD/CNY at 6.32 in 12 months. This should support most other Asian currencies against the USD. In particular, we expect the KRW to benefit as South Korea has a strong current account surplus and has brought COVID-19 under control.
