Going into 2021, almost every sell side analyst suggested the dollar would weaken this year, but the U.S. currency hassurprisingly appreciated instead. The ICE U.S. Dollar Index, a measure of the currency against six major rivals, has so farbounced nearly 3%this year following adecline of 6.7%in 2020. In the first quarter alone, the dollarclimbed 7.2%against the Japanese yen, while the euro in March dropped the most in three years against the greenback.
What happened? Expectations of a weakened dollar was based on loose monetary conditions in the U.S., inflation expectations, rising public debt and a robust global economic recovery. However, signs now suggest the U.S. will outperform other major economies as Europe struggles with its COVID-19 vaccine rollout. A robust U.S. economic performance could also mean divergence in monetary policy, with the Fed tightening monetary policy relatively more quickly than the ECB. "That could see the pace of dollar appreciation accelerate this year," BofAwrotein a recent research note.
While some analysts acknowledge they were quick to make forecasts, others aren't giving in. "We do not think that the long-term outlook for the dollar has changed,"saidCalvin Tse, a currency analyst at Citi, who still feels the currency could fall as much as 20%. However, Goldman Sachs this weekcanceled its short callon the dollar, saying after a "choppy few months we are closing our recommended dollar short trade.'
Outlook: The next move for the greenback may depend on whether the Fed will let the economy run hot. Last month, policymakers signaled expectations for interest rates that be kept at near zero through 2023, but some money markets are already positioning for a rate rise as soon as next year. Others suggest that even if the Fed would move early, the relationship has changed, as well as the currency's traditional role with equities. Once upon a time, a weaker dollar was seen as a boon for U.S. equities, but a stronger buck didn't prevent the continuous stock market highs that were notched in the first quarter.