U.S. Dollar Depreciation against the Pound and Euro to Continue in 2021 says Goldman Sachs

• USD to decline in 2021 says Goldman
• EUR/USD forecast towards 1.25
• Danske Bank says USD remains "long term winner"

FILE PHOTO - A view of the Goldman Sachs stall on the floor of the New York Stock Exchange. REUTERS/Brendan McDermid/File Photo

Goldman Sachs, the Wall Street bank with over $1.16 trillion worth in assets, have this week told clients they are expecting a continuation of recent U.S. Dollar depreciation to occur in 2021, given that it is still "meaningfully overvalued."

The Wall Street bank says their research shows the U.S. currency to be overvalued to the tune of about 10% on standard metrics and that a 6.0% decline in the trade-weighted value of the Dollar is possible over the course of the coming year.

"The Fed has also cut rates to zero, and its new policy framework should result in a long period of deeply-negative short-term real rates. The combination of high valuations and negative real rates skews the Dollar outlook to the downside, in our view," says Zach Pandl, an economist with Goldman Sachs in New York.

According to analysts, a rapid recovery in the global economy should weigh on the 'safe haven' Dollar, even if the U.S. economy performs well.

Economists have turned notably more constructive on the global outlook for 2021, citing the arrival of a vaccine as being a ticket to a permanent and sustained exit from the covid-19 crisis.

A global economic recovery would likely deprive the value of 'safe haven' demand, and favour a tranche of currencies that tend to benefit when the investors are bullish and the global economy is in an expansionary phase.

In particular, Goldman Sachs single out the Canadian and Australian Dollars as potential outperformers in this environment.

"The macroeconomic outlook has turned less favorable for the Dollar: the Fed has cut rates down to zero, removing the greenback’s carry advantage, and robust global GDP growth tends to lift the currencies of commodity exporters, emerging markets, and the economies most geared to global trade," says Pandl.

That said, the U.S. economy is not necessarily going to be in poor health, "we are optimistic about the US economy but bearish the Dollar," says the analyst.

Above: USD trade weighted index. If you have dollar based payments that you would like to lock in for use over coming months, please find out here about the tools available to you.

The stance of the U.S. Federal Reserve is a potential headwind, given that the rate cuts of 2020 have greatly diminished the interest rate superiority the U.S. has commanded over other developed market peers. The higher interest rates meant that the return on investment in U.S. assets for international investors was superior to that being offered in other developed market economies, thereby providing a tailwind for dollar gains.

Remove that tailwind, and the currency finds itself without a crucial leg of support.

"Low nominal and real interest rates are another vulnerability for the Dollar. The funds rate peaked at just 2.25-2.50% in the Fed’s last hiking cycle, but because interest rates," says Pandl.

Goldman Sachs are forecasting a sustained, yet orderly depreciation of the currency in 2021:

Given the assumption that the Dollar is going lower, Goldman Sachs are forecasting a Euro-to-Dollar exchange rate of 1.25 by the end of 2021, while the trade-weighted measure of the dollar will decline 6.0%.

The Pound-to-Dollar exchange rate is forecast at 1.44 by the end of 2021 and the Australian-to-U.S. Dollar exchange rate at 0.77. The New Zealand-U.S. Dollar rate is seen at 0.74 and the U.S. Dollar-Canadian Dollar exchange rate at 1.25.

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But the view for a weaker Dollar is by no means an universal one amongst the analyst community, with some saying it is too soon to call an end to the Dollar's period of strength.

Analysis from Scandinavian lender Danske Bank shows the Dollar should outperform in 2021. "We still see EUR/USD around 1.20 in 3M but longer term the USD is still ‘the winner’ and we forecast 1.16 in 12M," says Christin Tuxen, Head of FX Research at Danske Bank.

Tuxen notes the Federal Reserve has proven itself more hawkish than he had initially expected and, in turn, the USD has strengthened a little.

"US real rates have slightly increased vis-à-vis EU peers and this is somewhat USD positive," says Tuxen. "Fundamentally, the US should continue to be a high(er) interest rate market and equities continue to appeal to foreign investors. This means the US is likely to attract capital, which generally helps the USD."