Since mid-March, the USD has declined by over 8% on a trade-weighted basis. In particular, it has weakened against currencies with a high-beta to global economic growth, meaning that FX markets have priced in a recovery scenario for the global economy.
The Federal Reserve has cut interest rates back to all-time lows of 0.0–0.25% and it has pledged to keep rates at these ultra-low levels for a prolonged period. The Fed has also restarted its QE programme and it has agreed FX swap agreements with both advanced and emerging market central banks. The programme will keep US yields moored at incredibly low levels, across all maturities, meaning that the USD has lost a permanent interest rate advantage.
We believe that recent USD weakness is just the beginning of a multi-year USD depreciation trend. Because real interest rates in the US will be more deeply negative than in other economies, this will weigh on the USD as it gradually loses purchasing power over the coming years.
In today’s podcast we look at the broader outlook for the USD and we argue that EUR/USD can trade to levels of around 1.25 by the end of 2021.