| FX markets have become less U.S. dollar centric, with the U.S. dollar giving up much of its February gains despite a continued rise in nominal U.S. 10-year Treasury yields that now sit at the highest levels since February of last year. |
The dollar’s increasing divergence is illustrated by pairwise performance that shows a narrowing of dollar weakness. Over the past month, only ~60% of currencies have appreciated against a weakening dollar index versus ~90% of currencies during the November–December period that also saw a weakening dollar index. On a more granular level, high-yielding emerging-market currencies have been notable outperformers.
This wider dispersion in currency performance is reasonable given the growing divergence in the growth outlook among large countries. Looking ahead, this dispersion in dollar performance is likely to persist because macroeconomic performance still has the potential to widen. U.S. fiscal policy relative to other areas of the world, including the eurozone, has been much more expansionary, and potential fiscal stimulus also biases itself toward higher U.S. growth.
This week brings flash PMIs in the U.S., U.K. and euro area that will provide the latest look at growth prospects in these respective areas. The markets are expecting these PMI numbers to show resilience in the manufacturing sector despite continued COVID-19-related uncertainty. The services sector, which is more impacted by lockdown measures than the manufacturing sector, is expected to be a different story. While services PMI numbers are expected to increase in the U.K. and Europe, they are still expected to show continued contraction. Conversely, manufacturing and services PMIs in the U.S. are both expected to show continued expansion, albeit at a more moderate level.
As would be expected, vaccine performance is a key variable in the growth outlook, as vaccine distribution determines when lockdowns will ease and when a full recovery can take place. In order to better understand the potential upside from vaccinations, a study was done to rank countries based on 1) total doses administered per capita, 2) vaccines procured adjusted by population size and 3) the current state of the COVID-19 crisis.
Based on this study, the U.K. leads on doses administered and procured. Canada, the EU and Australia have done well on the number of vaccines procured but lag on deployment. High case numbers hurt the EU, U.K. and U.S., but the U.S. is running slightly ahead of some estimates on when it will achieve population immunity and should do so by the third quarter. Conversely, Japan is starting its vaccinations this week and should reach herd immunity around the end of 2021 versus the September–October period expected for the euro area.
The upshot for the U.S. dollar is that it should perform well against low-yielding, growth-challenged currencies, such as the euro, due to euroarea economic activity lagged other regions of the world. However, high-yielding currencies with strong economic fundamentals are likely to continue their outperformance as long as U.S. real yields remain in check (rising nominal yields have been matched by rising inflation expectations) and the broad-based global recovery continues.
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