What’s to come – currency markets in 2021

Nobody will forget 2020 in a hurry. This year has changed society locally, nationally and globally, and while some of those changes will be temporary, there are a huge number that may become a part of our way of living from here on in.

Currency markets, as the barometers of risk that they represent, had an incredibly volatile year with complacency leading to panic, isolation and, eventually, hope as a number of vaccines were developed. 2021 will see some semblance of normality resume but the longer-term effects of this pandemic, both economically and politically, will be felt long after ‘corona’ becomes a Mexican lager once again.

What does 2021 have in store for us?

At Equals Money, our overriding theme for 2021 focuses on this global recovery and the belief that investors and financial market participants will see investments away from the US dollar and the wider developed market world as the best place for their money next year. Commodity prices should remain high as demand recovers and global supply chains kick back into gear with consumers once again confident enough to spend money.

All of this will be underpinned by interest rates remaining at ultra-low levels through 2021 and, in certain cases, for many years after that. With plenty of change to come in the form of a new administration in the US, the resolution of Brexit negotiations between the EU and UK, and a global recovery from Covid, currency markets have plenty to contend with over the next 12 months.

Here, we take a deep dive into some key global currencies – GBP, EUR, USD, JPY, AUD and AED, and predict what 2021 has in store for each. Other currency predictions are available upon request

GBP

Covid-19 and Brexit will no doubt affect the UK economy for a lot longer, but with the rollout of a vaccine and a conclusion to trade talks by January 1st, we will at least have a degree of increased certainty for sterling, either positive or negative.

Despite this being written in early December, we are still unsure as to how the Brexit trade talks will conclude. For the purposes of this piece we have to assume that some form of deal – if only to eliminate the prospect of a full-fat no-deal outcome – is signed. While this will not allow for a dramatic improvement in trade terms and represents a huge logistical, financial and technological hurdle for the UK’s international businesses, the removal of the uncertainty over the UK’s trading relationship with its largest international partner will help sterling, if only a little and for a short amount of time.

What about no-deal?

Our central scenario is for the UK to obtain a thin trade deal with the EU but were this to not happen, then sterling will find the upcoming year incredibly difficult. Expectations vary but given that there is almost no risk premium priced into sterling i.e. almost no no-deal risk is currently in the sterling price, then the falls for the pound could be as much as 7-10%. This would put GBPUSD back towards 1.25 and GBPEUR towards parity.

Corona-recovery

As we have noted since news of a vaccine first hit the headlines, the UK is one economy that will benefit relatively more from a swift implementation of an inoculation. The UK economy is dominated by the services sector and the level of social components within that sector (shopping centres, restaurants, pubs etc) means that the ability for people to interact at less of a distance is crucial to the ongoing stability of the industry.

As a vaccine is rolled out, government focus will shift from health to wealth and changes that need to be made to the government’s fiscal position to put spending on a more sustainable pathway. We do hope that taxation does not increase in 2021 as it would likely penalise the recovery more than secure the nation’s fiscal future.

Politics should no longer hold such a sway over sterling in 2021 although upcoming elections in Scotland will likely raise the risk of another Scottish referendum over independence affecting sterling. We don’t think the referendum will fall within this parliament however. 

The Bank of England will likely maintain its stance of ultra-low interest rates for a number of years given the likelihood that inflation will run below its 2% target in 2021. We do not foresee a move into negative interest rate territory unless the UK leaves the EU without a trade deal.

So, what does this mean for sterling?

Given our expectations that we are in the beginning of a cyclical move lower in the USD and despite our belief that the pound will underperform on a trade-weighted basis, we are looking for a move higher in GBPUSD through 2021. Against most other currencies however, especially the euro, we think gains will be substantially more difficult to come by. EURGBP will likely trend towards the 0.90 level through 2021 in our expectations.

EUR

Lots of people like to hate the euro and there are a lot of reasons why the euro is a frustrating currency; the political system, the budget negotiations, the lack of a centralised fiscal policy and a central bank that has historically clipped the currency’s heels, all make the single currency a curate’s egg to analyse.

For once, the skies look a little brighter for the Eurozone although it is not the case that this is a completely cloudless view moving forward.

EUR is ending the year on a positive turn, mainly on the back of a decrepit dollar and we envisage that this euro strength – specifically in EURUSD terms – has a way to go in 2021. Markets are pleased that the Eurozone has managed to come together during a time of crisis and offer businesses and consumers both fiscal and monetary policy support.

Once those businesses are supported and consumers feel confident to return to some normality in their lives, then the pick-up in global trade should also help improve Eurozone growth prospects given its natural openness to free trade. 

Politically, the Eurozone is also a lot quieter in 2021 than it has been for a number of years. Long gone are the weekends of market fear over Greek parliamentary votes and gains made by nationalist parties in Spain, France or the Netherlands. Such a lack of political pressure coupled with a central bank that has shown its strength through the Pandemic Emergency Purchase Program, means that sovereign risk should become virtually non-existent next year.

What are the risks?

While the stimulus plans of the Eurozone has been heralded as one of the better reactions to the pandemic, sticking points remain particularly in the agreement of the latest EU budget. Both Hungary and Poland have expressed their dissatisfaction with the current deal and further delays will eventually delay help afforded to the wider Eurozone. 

Similarly, and while the effects would be catastrophic for the United Kingdom, should Brexit negotiations leave us in a position wherein the UK leaves the EU without a trade deal, then our forecasts of both Eurozone growth and the path of the euro would be dramatically lower.

Our central scenario remains that a deal is struck that simply afford enough scope to avoid no-deal i.e. nothing to write home about and leaves the UK with a definitively poorer trade outlook.

How high could we go?

As you’ll see below we think that the euro’s main pairs of EURUSD, EURGBP and EURCHF will likely see the single currency outperform with it losing ground against its nimbler cousins in Scandinavia and the emerging market.

USD

2020 has been a year of lessons for a lot of people. For some the lessons came from government in the form of washing hands, for those in currency markets, the lesson came from the dollar. That lesson? When the proverbial hits the fan and liquidity gets tight, the dollar is the place to be.

It is therefore almost amazing that the dollar index – the value of the USD across all of its trading pairs – is ending the year roughly where it began. We entered the year thinking that the USD would likely need some help to pull higher and we believe that a real change could be on the cards for the USD in the coming months and years.

First of which is the expected return to normalcy and the dollar is strongly, negatively correlated with global growth; as the globe positions itself to rocket back from the decline seen in the various lockdowns we have suffered through, the dollar should continue to push lower.

Trumped out

The largest political event of the year saw Donald Trump lose the White House to Joe Biden. His main influence economically has been expressed via trade. We expect tensions with China to remain, but a centrist President like Joe Biden to maintain some of Trump’s trade policy to avoid looking ‘soft’ on China. As much as Biden would love to come in and cut tariffs on Chinese goods, there is no point in helping an economic rival straight out of the gate. 

In the coming months, tariffs will likely be replaced by non-tariff barriers and we expect intellectual property laws to be fiercely debated. That being said, US businesses have struggled with international relations in the Trump administration and a calmer stewardship of trade should boost corporate profits in coming quarters and allow for further USD depreciation.

Stimulation nation

In a Biden administration, gradually spending will rise, although it will be a battle to hike taxes through a Republican Senate. If the US is looking for stimulus it may have to look at the Federal Reserve to do some of the heavy lifting, offering another route to a lower dollar. The appointment of former Fed Chair Janet Yellen as Treasury Secretary will help matters well.

In a world of relative returns, if the UK, Asia or the Eurozone are able to turn the corner on a recovery from the pandemic faster than the US, driven by appropriate stimulus spending locally, then we would expect the dollar to lag GBP, EUR and some emerging market currencies moving forward.

JPY

One of the most interesting currencies to watch since the US election has been the Japanese yen. For a long time, and certainly through the Covid-19 crisis, the yen has been used as a safe haven from negative investment sentiment and has pushed higher against other currencies.

Typically when sentiment changes into a more positive mood, the yen would then sell off as investors use its low-yielding properties as a funding currency to power more attractive investments elsewhere. 

Since the election of Joe Biden however, the JPY has continued to strengthen whilst risk assets have also moved higher. Some attest this to the strange markets that we are currently navigating; vaccine joy tempered by very real near-term pandemic problems whilst others believe that investors are positioning themselves for a wider retreat in the USD and hence a move lower in USDJPY is all but guaranteed.

That may be the case for USDJPY but against the EUR and GBP, yen will likely bow to the pressures put on it by investors looking for cheap funding. We doubt that the Bank of Japan will choose 2021 as the year in which to stage a reversal or any change to its current ultra-loose, negative interest rate monetary policy environment and that will limit the ability of the yen to rally dramatically from here.

We can’t talk about the yen without talking about the prospect of intervention in the yen should the currency become overly strong. Given this hasn’t taken place since the Bank of Japan intervened in 2011 following the Tohoku earthquake and tsunami, when USDJPY was 20% lower than it is now, something dramatic is going to have to take place for the BoJ to feel the need to intervene.

In summary, whilst the JPY may enjoy some strength against the USD in the coming year, we expect it to slip on a broader basis.

AUD

AUD has been the poster child for the recovery in risk assets since the early, darker days of the pandemic and its continued position at the front of the pack is probable, but in no way guaranteed by the path of the global economy in the coming 12 months. Unfortunately, even more so than usual, the fate of the Australian economy and the dollar is almost exclusively in the hands of other people.

Chinese double-edged sword

Exports to China are worth 260% of Australia’s next most valuable trading partner – Japan – and the continued demand for commodity exports from China kept both commodity prices and the AUD well supported through the pandemic. The main exports of both iron ore and coal are set for price falls as supply issues that have dominated markets during the pandemic fade.

Relations between China and Australia have soured somewhat through 2020. Initially this started following Australia joining others in the international community in asking for an independent enquiry into the evolution and spread of the Covid-19 virus, but the mood has improved and recent moves have seen China impose tariffs and bans on some Australian exports.

At the moment this covers coal, copper, wine, sugar, timber, cotton, beef and lobster to varying extents, but an oversized impact will come should China start to target iron ore or LNG. At the moment, we do not see this happening for two reasons:

  1. International relations tend to improve as economies get richer as both China and Australia will do in bouncing back from the pandemic.
  2. Trade is set to become a lot more predictable with China as a whole given the election of Joe Biden and the gradual softening of Trump trade policy.

Sunshine is the best disinfectant

Australia’s handling of the Covid-19 crisis is broadly comparable to New Zealand’s although the strength of the contagion in the state of Victoria meant longer lockdowns than was originally envisaged. With the news that multiple vaccines may be available in the coming months and Australia entering the summer, limiting the transmission of a respiratory disease, Australia is in a prime position to get back up and running a lot quicker than those of us in the Northern Hemisphere. 

Central bank on standby

The Reserve Bank of Australia has been one of the most aggressive central banks in combating the economic effects of the pandemic but it will be tricky for them to maintain that level of aggression moving forward. 

Unlike their antipodean cousins, the RBA has stepped away from talking about negative interest rates and we think that threats of their use will lack credibility going forward, a strong AUD will likely breeze through them. 

In summary, if market minds are focused on a recovery then we will be looking for a higher AUD, and it is not out of the realms of possibility that AUD outperforms the majority of the G10.

AED

We are going to see some cheaper dirham prices if the US dollar behaves as we believe it will do through 2021. Our belief that a near-perfect storm of dollar devaluation influences (higher inflation, deficit spending, a global recovery from Covid-19 and a trade-tolerant President) are going to hit in 2021 should see those currencies pegged to the USD also in the crosshairs.

We expect to see the AED lose around 4-5% of its value in the coming 12 months.

Looking for another currency?

Our Chief Economist has compiled 2021 predictions for a wide range of currencies including Russian ruble, Hong Kong dollar, Swiss franc and more. Email fx@equalsmoney.com with the currencies you’re looking for and our team will get in touch.

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Jeremy Thomson-Cook

Jeremy Thomson-Cook

Jeremy has over 13 years experience working in the FX industry. As a specialist in political risk mitigation and currency hedging, he regularly advises clients on the day-to-day moves of the markets and the implications of fiscal and monetary policy on international businesses.