A tale of two dollars

perspectives d’investissement

A tale of two dollars

Vasileios Gkionakis, PhD - Responsable de la stratégie FX globale

Vasileios Gkionakis, PhD

Responsable de la stratégie FX globale
Kiran Kowshik - FX Strategy

Kiran Kowshik

FX Strategy
Homin Lee - Stratège macro - Asie

Homin Lee

Stratège macro - Asie
Sophie Chardon - Stratège cross-asset

Sophie Chardon

Stratège cross-asset

Key takeaways

  • Market environment is currently characterized by far too many risks and moving parts
  • Consequently, forecasts are subject to unusually large margins of error
  • Overall, it is now certain that global growth will take a substantial hit in H1 2020, but our central scenario still envisages a rebound in H2 2020
  • Assuming this is right, and taken alongside the extraordinary Fed actions, the convergence of US rates both lower and closer to G10 peers should put the dollar under pressure against the major reserve currencies over the course of 2020
  • On the other hand, the USD could be well supported against large parts of EMFX given the new “low for longer” backdrop for energy prices
  • However, we still expect the CNY and parts of Asia FX to outperform after the initial shock
  • The key risk here is a re-emergence of the dollar liquidity squeeze, which would result in renewed USD appreciation.

The last few weeks were characterized by a nearly unprecedented increase in the level of uncertainty with steep equity market losses and huge swings in bond and FX rates. This is an environment with far too many risks and moving parts, namely: 1. The extent of the virus pandemic and its evolution, 2. Monetary policy responses (and their efficacy), 3. Timing, size and composition of fiscal stimulus, 4. The side effects of various country restrictions in place and, 5. Developments on the recent USD liquidity squeeze.

Consequently, our forecasts are subject to an unusually large margin of error. It is impossible to incorporate the uncertainty relating to so many factors in our estimates 2-3 quarters ahead. The best we can do is to interpret the moves, asses their evolution and then lay out our central scenario, which remains subject to sizeable uncertainty. 

The elephant in the room is fiscal policy.

In summary, our working assumptions revolve around the following points

  1. The virus pandemic will substantially suppress economic activity in Q1 and Q2 but still the odds are for a recovery in H2 2020, aided also by the significant amount of stimulus provided.
  2. Monetary policy has responded forcefully, using both conventional (rate cuts) and unconventional quantitative easing (QE) measures. However, the elephant in the room is fiscal policy. In that sense, size does matter but composition is equally important. Public health measures aimed at “flattening” the virus infection curve are needed alongside measures that enable firms to sustain the costs related to the abrupt drop in demand and costs associated with retaining their employees. In recent days, several countries have made very important steps (see here and here for example), which we believe will be quite supportive. And more is likely to come.
  3. The US Federal Reserve will (hopefully) eventually manage to address the USD liquidity squeeze in the market, which was responsible for the surge in the dollar since early March. The announcement of unlimited QE and the (unprecedented) addition of investment grade corporate bonds in the asset purchase list by the central bank are big steps in the right direction.
  4. However, and outside the control of authorities, other crucial variables such as energy prices – which are OPEC driven - will remain a drag for large parts of the emerging markets.
The Fed will (hopefully) manage to address the USD liquidity squeeze in the market.

Based on these working assumptions, lower US yields will converge closer to other G10 peers increasing the importance of rate differentials and eventually pressuring the USD, especially against the majors.

We have pencilled-in EURUSD at 1.16 for year-end, EURCHF at 1.08, GBPUSD at 1.28 and USDJPY at 103.  However, we bear in mind the very high volatility, which can result in extremely choppy markets of 4-6% around point forecasts.

On the other hand, we expect the USD to be well supported against large parts of EMFX given the new “low for longer” backdrop for energy prices. However, we still expect the CNY and parts of Asia FX will outperform after the initial shock.

In this sense, it will be a “tale of two dollars”: softer against the G10 reserve currencies (EUR, JPY, CHF, and gold) but stronger against EMFX (barring CNY and parts of Asia).


Clearly, risks to our view are sizeable but also symmetrical. These include

  1. The pandemic worsening further and delivering a more severe and longer lasting impact on the global economy (USD-positive via more severe USD liquidity squeeze).
  2. Failure by the Fed to address the USD liquidity stress issue (USD-positive).
  3. A very sharp rebound in the global economy in H2 2020 (USD-negative).
  4. OPEC+ countries sort out their differences and reinstate their alliance (EM FX-positive).

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