There are many reasons to expect a weaker US dollar next year and perhaps for longer, but none more important than the new political position of the Federal Reserve.
The US dollar briefly rallied in March due to its role as a haven in investment portfolios. Since then, it has fallen by about 12% against a trade-weighted basket of currencies, as the US has proven to be even more affected by the coronavirus pandemic than most major economies.
As vaccines are launched and the global economy recovers, this trade will not necessarily work the other way around. Rather, the currencies of countries that export goods and manufactured goods will continue to strengthen against the dollar, as would be seen in a typical global recovery. Some Asian exporters are already quietly intervening to limit the growth of their currencies.
But this time, the reasons for expecting a weaker dollar run even deeper. A few years before the pandemic, US interest rates on both the long and short ends of the yield curve were substantially higher than in Europe and Japan – a major source of strength for the US currency. This premium has largely disappeared as the Fed cut short-term rates to almost zero and launched a new round of asset acquisitions. The yield on 10-year US Treasury bills has fallen from almost 2% earlier this year to about 0.93% now.
Granted, it is still much higher than the 0.02% and minus-0.58% yields of 10-year Japanese and German government bonds. But real US yields are actually lower depending on inflation, says market economist Simona Gambarini of Capital Economics. In the US, the core consumer price index was 1.6% higher than a year earlier in November. This compares with slight deflation in Japan and the euro area.