2021: Will the U.S. dollar enter a downward channel?

2020: The U.S. dollar goes down in shocks
In 2020, the new crown epidemic swept the world, and the US dollar index fluctuated sharply under “unexpected shocks”, showing a three-stage market. From the beginning of the year to mid-February, the US dollar index fluctuated slightly and even rose under the background that the United States had not yet suffered the impact of the epidemic and the economic operation continued the trend of the previous year. From late February to mid-May, with the global pandemic of the new crown epidemic, the US dollar index began to rise and fall dramatically, and the US dollar index once soared above the 103 level. From mid-May to the end of December, the dollar index trended downward. At the end of 2020, the U.S. dollar index was at a level of about 90, a drop of more than 12% from the peak of the year and a drop of 6.4% from the beginning of the year.

In 2020, the U.S. dollar index tends to decline in shocks, mainly due to three factors. First, the economic outlook for the United States is sluggish. Under the impact of the epidemic, the U.S. will be plunged into the worst economic recession since the Great Depression in the 1930s in 2020. It is estimated that the GDP will shrink by 4.5% throughout 2020. Affected by this, the US dollar index entered a downward channel. The second is the ultra-loose fiscal and monetary policy. In 2020, in order to rescue the market, the United States adopted a loose fiscal and monetary policy, which was significantly stronger than other developed economies, and weakened the international credit and intrinsic value of the dollar. From the perspective of fiscal policy, since the outbreak of the epidemic, the United States has implemented four rounds of fiscal stimulus plans, with a total of 2.9 trillion U.S. dollars, accounting for 12% of U.S. GDP. In fiscal year 2020, the US fiscal deficit will reach 3.13 trillion US dollars, accounting for 15.2% of GDP, a record high. From the perspective of monetary policy, as of the end of 2020, the Federal Reserve has cut interest rates and expanded its balance sheet by more than US$7 trillion, which is far more easing than the central banks of Europe and Japan. Third, the relative return on assets of the U.S. dollar has fallen. Since the second quarter, although the global economy is still in recession, with the introduction of large-scale rescue measures from countries around the world and the Federal Reserve’s significant reduction of benchmark interest rates, the US dollar has excessive liquidity, and investors’ risk appetite has shifted from a hedging model to risk Mode, funds began to flow to markets in Europe, China, South Korea and other markets where the epidemic was relatively well controlled, and the dollar began to weaken.

The dollar’s decline in the short to medium term is limited
Looking forward to the future trend of the US dollar exchange rate, it is necessary to combine long-term, medium-term and short-term factors to analyze and judge comprehensively.

In the long run, the U.S. dollar is likely to enter a downward cycle. The trend of the US dollar exchange rate is cyclical. This round of the dollar index rising cycle started in the second half of 2011, and it has been more than nine years since it has surpassed all previous cycles. At present, the real effective exchange rate index of the US dollar is about 115, which is relatively high in history, and there is a high probability that it will tend to decline in the future. The fundamental reason for the decline of the dollar is that the long-term trend of the dollar does not depend on domestic supply and demand, but on global supply and demand, that is, the dollar’s international currency status. Behind this is the rise and fall of major powers and the balance of power. In the past few decades, although the United States has remained the world’s largest country, it is an indisputable fact that its relative strength has declined. The proportion of US real GDP in the world has dropped from about 40% in the 1960s to 24% in 2019, and the US’s contribution to global growth has dropped from 24% at the beginning of this century to 15.8% in 2019. “The trend continues. At the same time, America’s growth advantage and wealth status are also being weakened. The dividends of scientific and technological innovation at the beginning of the 21st century are fading. The global share of the US PCT (Patent Cooperation Treaty) patent applications has dropped from 41% in 2000 to 22% in 2020, and the global share of wealth has also dropped from that of the beginning of this century. 35.6% fell to 29.4%. With the relative decline in the overall strength of the United States and the diversification of the international monetary system, from a long-term perspective, the US dollar will enter a downward channel.

Dollar index trend

Source: Wind (Wind Database)

In the short to medium term, the US dollar exchange rate center will show a slight downward movement and wide fluctuations, but the overall decline will be limited. Although the long-term trend of the U.S. dollar, the U.S. economic outlook, and ultra-loose policies have suppressed the U.S. dollar exchange rate center, the decline of the U.S. dollar exchange rate in 2021 will be relatively limited.

First, although the US economy is showing a weak recovery, the pace of recovery may be better than that of Europe and some emerging economies. On the demand side, American household balance sheets are relatively stable, and consumption may pick up quickly. At present, the U.S. residential sector leverage ratio is 75.2%, which is much lower than the level when the financial crisis broke out in 2009. The implementation of the new round of fiscal stimulus plan and the superimposed stock market rise will support the growth of disposable income and household consumption. In the post-epidemic phase, US consumption, especially service consumption, is expected to accelerate the recovery. On the supply side, once the epidemic is brought under control, U.S. production and services will quickly resume. Recently, the economic prosperity of the United States has improved. Although it still faces major challenges, it is generally better than it was at the beginning of the outbreak. In addition, Biden’s ruling in 2021 may bring some positive factors, such as vaccine applications, support for “Made in the United States”, expansion of infrastructure investment, and repair of relations with allies, which will help the United States’ economic recovery.

Second, interest rate differentials and their expected changes will have a certain supporting effect on the US dollar index. In 2021, the Fed’s monetary policy will continue to maintain an ultra-loose tone, but policy expectations in the second half of the year may change. The pace of balance sheet expansion and marginal increase may slow down compared with Europe, or it may trigger discussions and expectations on the normalization of monetary policy. Thereby reducing downward pressure on dollar arbitrage. Although the Federal Reserve has adjusted its monetary policy framework and increased its tolerance for inflation, economic recovery and a rebound in inflation will still drive the long-end yield curve of U.S. debt to rise, which in turn will support the trend of the U.S. dollar.

Third, the US dollar is still the world’s most important international currency and safe-haven currency. The U.S. dollar accounts for approximately 45% of international payments, 88% of global foreign exchange transactions, 47% of global financing (the stock of bond bills), and 62% of global reserves. Although the euro’s market share in the field of international payments has surpassed the dollar recently, the international status of the dollar is hard to shake. The international exchanges of the world’s main bodies still use the US dollar as the main intermediary, and the increase in the euro is not enough to make up for or replace the use of US dollars. At the same time, in 2021, long and short factors are intertwined, and market sentiment may change. The optimism about vaccine launches will gradually cool down, and market expectations will return to rationality. Both epidemic prevention and control and economic growth are facing challenges. On the one hand, less than 70% of the global vaccinated population will be vaccinated in the next year. The epidemic is at risk of virus mutation and staged deterioration. The resonance effect of the global economic recovery may not be as expected. On the other hand, considering the lag in vaccination time, developed countries, especially the United States, are recovering relatively faster than emerging markets. The economies of some emerging markets are likely to fall into recession, financial vulnerabilities will increase, and geopolitical risks will rise. This may aggravate financial market turbulence and help. Push the dollar index to rebound in stages.

To avoid rapid appreciation of the RMB exchange rate
The US dollar is the largest currency in my country’s cross-border revenue and expenditure, and its trend has a significant impact on the RMB exchange rate and my country’s economic and financial development. Since April 2020, in the context of the weakening of the U.S. dollar, the exchange rate of the renminbi has generally shown a situation of rising volatility. As of the end of December, the RMB exchange rate against the US dollar was about 6.5, which has appreciated by more than 6% from the beginning of the year. The rapid appreciation of the RMB exchange rate in this round is mainly due to the fact that my country is ahead of overseas markets in terms of epidemic prevention and control, economic recovery, and monetary policy cycles. It is not that the RMB exchange rate has entered a trend upward channel. In the next period of time, the domestic and foreign environment will move from the abnormal state under the impact of the epidemic to the post-epidemic phase, with increasing instability and uncertain factors, the long-short game will become more intense, and the volatility of the RMB exchange rate will further increase. In the short term, news and expected factors have a greater impact on the RMB exchange rate, which may magnify the positive or negative effects of fundamentals and technical aspects.

In this regard, my country needs to pay close attention to the possible negative effects of the excessive appreciation of the RMB exchange rate, be alert to the formation of a “vicious circle” between short-term capital flows and the RMB exchange rate in sensitive periods, and focus on the following three aspects. One is to maintain the flexibility of the RMB exchange rate. At present, with the economic recovery of some countries and the recovery of external demand, the RMB exchange rate is objectively required to have a certain degree of flexibility, so as to maintain the resilience of my country’s foreign trade and balance of payments, and prevent the excessive appreciation of the RMB from triggering large-scale inflow of international hot money. Impact on the domestic economy. The second is to improve the management of cross-border capital flows. Focus on monitoring the flow of short-term speculative capital, and strengthen the tracking and monitoring of the scale, motives and flow of cross-border capital flows. In particular, attention should be paid to capital inflows without actual trading background. The third is to further improve exchange rate risk management capabilities. From a policy perspective, orderly release the pressure of exchange rate appreciation and depreciation, consider strengthening credit and liquidity management under the loose monetary tone, and alleviate the pressure on the RMB exchange rate and asset prices to rise too quickly. From the enterprise level, sort out the concept of financial neutrality, carry out hedging based on actual needs, improve accounting, taxation, and incentive mechanisms, and reduce exchange rate risk management costs.