HSBC Forecast Limited U.S. Dollar Weakness in 2021

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Foreign exchange analysts at HSBC have updated clients with their forecasts for the U.S. Dollar, saying they see some weakness ahead for the Greenback but that the downside should be limited.

In a disappointing verdict for Dollar bears, HSBC says that any declines will likely be cyclical in nature as opposed to structural, meaning that any weakness won't stem from a vote of no confidence in the currency by investors.

There were concerns coming out of various quarters in 2020 that the country's gaping budget deficit (spending) and current account deficit (trade) would prompt investors to abandon the Dollar as confidence in U.S. assets plummeted.

But, if anything, HSBC says that the increased spending being sought by President Joe Biden could in fact help the U.S. economy outperform the rest of the world, which is a Dollar positive outcome.

This "U.S. exceptionalism" was a driver of U.S. Dollar strength through much of the Trump administration and there were expectations that this exceptionalism would wane in 2021 as the rest of the world saw a strong post-covid recovery.

But this consensus view was tested in January and into February as the Dollar made a comeback, leading some analysts to say the market was bidding the currency on an expectation for U.S. economic outperformance.

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"The USD’s resilience to the recent rally in equities has rejuvenated the 'US exceptionalism' theme," says Daragh Maher, Head of U.S. FX Strategy at HSBC.

U.S. President Joe Biden is looking to pass a $1.9BN stimulus package in an attempt to shore up the economy in the face of the ongoing covid crisis.

The generosity of the support relative to the support offered elsewhere in the world leaves the U.S. economy in a stronger position to rebound when the medical crisis fades.

Analysts at HSBC expect any rebound in economic activity will in turn prompt the market to question when the Federal Reserve will start exiting its stimulus programme.

Should the economy start expanding, inflation start rising and unemployment fall, then the Fed will likely start considering raising rates and exiting its quantitative easing programme.

The exit from quantitative easing stimulus is known as a 'taper' in financial circles and is typically associated with Dollar strength.

This is because by cutting back on quantitative easing the Fed would effectively be allowing the yield paid on U.S. debt (treasury yields) to rise. If they rise faster than yields elsewhere in the world this creates an inflow of foreign capital into the U.S.

This inflow of capital in turn bids the Dollar higher.

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"We expect this dynamic to be sustained in the coming years with fiscal expansion likely to be viewed once again in terms of its implications for future growth and the path of monetary policy," says Paul Mackel, Global Head of FX Research at HSBC.

"Although rate hikes by the Fed remain a distant prospect, any fiscal boost to US activity may foster a renewed focus on a tapering of the Fed’s bond purchase programme," he adds.

HSBC forecast the Euro-Dollar exchange rate at 1.24 by mid-year and 1.26 by year-end. The Pound-Dollar exchange rate is forecast at 1.34 by mid-year, where it is expected to remain through to year-end.

Dollar-Yen is forecast at 103 by mid-year and 102 by year-end while the Australian Dollar-U.S. Dollar exchange rate is forecast at 0.79 and 0.81 for these respective timeframes. The U.S. Dollar-Canadian Dollar rate is forecast at 1.24 mid-year and then 1.22 by year-end.

"US dollar gains early in 2021 in response to an admittedly premature discussion of the merits of tapering, likely provides the blueprint for the reaction function later this year. It is partly why we believe the weakening trend in the USD will be limited in scale and longevity," says Mackel.