FX Viewpoint 18 May 2021 | Article – HSBC VisionGo
- Broad USD weakness has gathered pace recently
- The drivers of the FX market are steering towards expected policy normalisation but it is still a long journey
- We still expect modest USD weakness this year, but the USD could outperform other currencies over the long run
The global economy has steadily embarked on a recovery path from the worst of the pandemic. Over the past month, the USD has reversed most of its gains posted in Q1 this year (Chart 1). This coincidence is, however, not a straightforward outcome.
In our view, there are mixed influences in determining the path for exchange rates this year. Risk appetite remains relevant but has been less impactful since the beginning of the year and for good reason too. As we move away from the epicentre of a market shock (i.e. March 2020), over time, there should be a re-establishment with the pre-crisis drivers for exchange rates. The belief that the global economy is gradually healing should imply that some future degree of monetary policy normalisation will eventually occur, which is then partly discounted by exchange rates today.
Risk appetite remains a relevant FX driver, but expected policy normalisation will eventually become more prominent going forward
The Federal Reserve (Fed) is only willing to change to a more hawkish stance if the rise in growth and inflation turns out to be durable rather than transitory. Nevertheless, the volatility in recent activity data and noisy inflation base effects imply that this probably will not become clear until later this year.
We still expect modest USD weakness this year, as the global economic recovery gains momentum
In our view, as long as US fiscal and monetary stimulus is generating spill-overs for the rest of the world, such that there is a synchronous global recovery (Chart 2), albeit at somewhat uneven speeds, the broad USD is to weaken modestly. The other thing to note is that vaccinations in other parts of the world are gradually catching up.
The finish line is still very far away and while the USD is seen underperforming for now, we remain mindful of the conditions that could see it regain its momentum and leapfrog other currencies over the long run.