2020 has been a year of unprecedented extremes. The year saw both the steepest synchronized global contraction in history and a nearly as steep, but still incomplete, rebound driven by unprecedented deficit spending and a balance-sheet-busting global policy response. As we head into 2021, the global economy is laying the foundation for a normalization across a variety of areas, including: - The global environment. Earlier than expected viability of multiple vaccine candidates has opened up the path toward economic normalization.
- U.S. foreign and trade policy. The election of a conventionally moderate president should bring about a more deliberate policy path. A split Congress, pending the runoffs in Georgia, gives less room for major policy changes and the associated uncertainty surrounding such moves.
- Monetary policy. The pandemic put global central banks into crisis mode and triggered a synchronized global drop in yields. Central banks have moved away from crisis management toward accommodation. While this is a step toward normalization, we are still a few years away from full normalization, as rates are expected to remain near the effective lower bound for some time, and QE programs should continue to be tweaked.
- Politics. The political calendar is fairly quiet, with few potentially market-moving elections among the major economies. The German federal election will see the end of the Merkel era but should not change domestic policy or Germany’s pro-EU position.
As a result of the above normalization, the U.S. dollar should trend lower in 2021 as the global recovery continues. Outside of the drastic moves seen at the start of the pandemic, the dollar has traded along with the broad global outlook. So if the 2021 global backdrop is one of a lower volatility recovery supported by vaccines, then it is reasonable to expect the U.S. dollar to continue to drift lower.
Given this, dollar weakness next year should be to a lesser degree than seen during the initial growth rebound earlier this year. Over the past two recessions, the dollar has consolidated after the initial selloff before resuming trend weakness during the latter part of the recovery. This period of consolidation typically comes after the initial growth spurt as economies come out of a recession.
Another factor moderating U.S. dollar weakness in 2021 is the completion of interest rate convergence. The U.S. entered 2020 with one of the greatest capacities to lower rates in the developed markets and did so. The synchronized drop in global rates led to a rotation out of previously high-yielding/overweight currencies such as the dollar into low-yielding/underweight currencies. But this rotation is a one-time driver, as rates around the world are all near zero.
With policy rates pinned to the lower effective bound and QE programs maxed out, monetary policy differentiation should be less of a driver than in other cycles. Instead, balance-of-payment dynamics should matter more, favoring surplus currencies such as the Swiss franc, Japanese yen and Chinese yuan. | |
| HERE ARE THE KEY NEWS STORIES FROM OVERNIGHT: | |
- News reports indicated that Congress will pass a one-week continuing resolution to keep the government open, as pandemic relief talks remain stalled. Senate Majority Leader Mitch McConnell has made limits on business liability lawsuits a priority, and this could be a potential deal breaker. Notably, McConnell has yet to officially endorse the latest $908 billion compromise bill, and it is believed that he still prefers a targeted (i.e., smaller) relief bill.
- Brexit talks continue to hang by a thread. U.K. Prime Minister Boris Johnson will travel to Brussels in hopes that high-level talks will be able to bridge the differences. The U.K. also passed the Internal Market Bill after the controversial lawbreaking clauses were removed. On the margin, Johnson’s willingness to drop the controversial clauses is a positive, as it eliminates a self-imposed obstacle, but recent comments around Brexit talks have been decidedly negative.
- Progress in passing the EU budget remains hard to find. As a result of the protests from Poland and Hungary over the rule-of-law conditions, the EU is working on removing the two countries from the recovery fund. Ultimately, a deal is still expected, as Poland and Hungary stand to lose the most economically and politically should the recovery fund not pass, but this type of brinkmanship is the last thing the EU needs amid the pandemic and weak economic conditions.
- The Pfizer-BioNTech vaccine appears set to win FDA approval after the FDA said the vaccine shot is safe and effective. In the U.K., the inoculation campaign began today.
- Germany’s ZEW expectations survey came in much firmer than expected, with the series coming in at a 55.0 print versus expectations for a 46.0 print. The current situation component slightly missed at -66.5 versus expectations for -66.0. This dynamic of a miss on the current situation but a beat on the expectations component reflects the progress that Europe has made on controlling the virus since the mid-November peak.
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