The US dollar is back

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In some of my articles over the past few years, I have looked at the exchange rate movements over different time periods, mainly in relation to the value of EUR versus USD and GBP as these are the main ones. currency movements which are mainly watched by Maltese investors.

The EUR to USD exchange rate showed a high degree of volatility throughout 2020. It started the year at the US $ 1.12 level and the US dollar strengthened considerably around the third week of March at nearly US $ 1.06 following US approval. Senate of the historic US $ 2 trillion stimulus package (the largest emergency aid package in the country’s history) on March 25. the COVID-19 pandemic.

The US dollar weakened again to break above the US $ 1.11 level shortly thereafter and traded in a relatively narrow range until the end of May.

However, the euro rally gained momentum from the end of May as the market digested the European Commission’s proposal for a € 750 billion “Next Generation” stimulus fund, financed by the European Union. mutual debt issuance and provided in the form of loans and grants to eurozone members.

One of the main factors that negatively impacted the performance of the euro in the previous weeks has been the resurgence of fears of a collapse of the single currency, but the ‘Next Generation’ stimulus fund has largely been interpreted as a rare landmark achievement in terms of solidarity and unity across the EU.

During the second half of 2020, the US dollar was negatively affected by heightened uncertainty over the US economic outlook due to the wider spread of the pandemic, as well as by the outcome of the presidential election.

The EUR vs USD exchange rate ended the year at the level of US $ 1.23. The US dollar weakened by 9.9% against the euro and towards the end of last year, many analysts who issued their forecasts for 2021 for the various asset classes generally agreed that the US dollar would weaken again in 2021.

This assumption was based on a number of factors such as the extent of the US Federal Reserve’s efforts to keep interest rates low through bond purchases and ultra-accommodative monetary policy, as well as increasing levels of indebtedness in the United States which may have constrained other options for stimulating economic growth.

However, the US dollar has rallied in recent weeks and is now at a five-month high against the euro. The euro had appreciated to a multi-year high of US $ 1.2349 in early January 2021.

The dollar reversal began when newly elected US President Joe Biden pushed through the $ 1.9 trillion US bailout to stimulate the economy in the wake of the pandemic shock. In addition, the pace of vaccinations in the United States has increased from around 900,000 doses per day to nearly three million doses per day, giving hope for a faster and wider economic rebound after the pandemic.

Higher economic growth expected in the United States relative to eurozone economies should lead to higher inflation levels and faster Federal Reserve action

In fact, over the past few weeks there have been a series of dramatic upward revisions to America’s GDP growth forecasts and the US economy is now expected to outperform other developed economies significantly. . According to the OECD, the US bailout is expected to add three to four percentage points to 2021 GDP. US GDP growth is now expected to reach 8%, which will mean increased sales and profits for companies across the United States. United States, indirectly leading to strong demand for the US dollar.

Additionally, although the Federal Reserve’s dot plot released earlier this month suggests that interest rates will stay close to zero until 2024, the interest rate differential is another factor supporting the dollar. American, given negative interest rates in other regions, particularly in the euro zone. .

Most international financial analysts do not expect any change in the European Central Bank’s monetary policy measures anytime soon, and interest rates in the EU are already the most negative in the world (with the exception of the Switzerland), which makes the maintenance of the euro unattractive. One particular financial reporter actually commented that “the European Central Bank appears ready to keep interest rates close to zero indefinitely”.

The euro has also been hit by the slowness and problems of vaccine supply, as well as the increase in COVID-19 infections in many countries, leading to further lockdowns in major economies, including the Germany and France.

Some currency analysts are now forecasting that the US dollar’s rally will likely continue through 2021, helping the greenback recover some of the losses it suffered against the euro last year.

One reason given is that the significant US $ 1.9 trillion budget relief plan could eventually lead to a normalization of monetary policy by the Federal Reserve, which should support the recent strength of the US dollar. The higher expected economic growth in the United States compared to eurozone economies should lead to higher inflation levels and faster action by the Federal Reserve.

The recent volatility of the EUR against USD exchange rate is compared to movements seen in 2017 and 2018. In 2017, with global economic growth being widespread, the US dollar was on a downtrend, but the Federal Reserve raised interest rates . in 2018, the dollar strengthened as a result.

So, while US economic growth is expected to vastly outperform most developed economies significantly in the coming months, which will ultimately contribute to economic growth in other regions, coupled with the acceleration of vaccination rollout. in Europe, some monetary strategists believe that the US dollar could weaken again in due course.

The EUR vs USD exchange rate is therefore likely to remain volatile in the coming months given the different drivers of currency movements such as trade flows, relative interest rates and risk appetite.

While it is important to monitor currency movements from period to period because of the impact this can have on the overall performance of an investment portfolio (especially when a major currency can gain or lose almost 10 percent in a single year, as was the case in 2020), it is also important for long-term investors to assess whether currency movement is one of the main factors to be taken into account as part of the overall structure of its portfolio.

Any long-term investment portfolio should have exposure to the US dollar given the size of the US financial market and the quality of companies present in the US, as has been notable especially in the tech sector in recent years. . As such, while it may be important to exercise discipline over exposure to a currency other than the national currency, this should also be considered as part of the overall objectives of an investment portfolio.

When building investment portfolios for long-term financial planning purposes, the annual movements of a currency, which can be large at times, should not be the primary factor that drives investment decisions. Hopefully over time these currency moves would be offset by capital gains, as evidenced by the S & P500’s compound annual growth rate of nearly 12% over the past 10 years.

Rizzo, Farrugia & Co. (Stockbrokers) Ltd, “Rizzo Farrugia”, is a member of the Malta Stock Exchange and licensed by the Malta Financial Services Authority. This report has been prepared in accordance with legal requirements. It was not disclosed to the named company (ies) prior to publication. It is based solely on public information and is published for informational purposes only and should not be construed as a solicitation or an offer to buy or sell any securities or related financial instruments. The author and others concerned may not trade in the securities to which this report relates (other than the execution of unsolicited client orders) until the recipients of this report have had a reasonable opportunity to act on it. Rizzo Farrugia, its directors, the author of this report, other employees or Rizzo Farrugia on behalf of its clients, hold interests in the securities mentioned herein and may at any time make purchases and / or sales therein. as principal or agent, and may also have other business relationships with the company (s). Stock markets are volatile and subject to fluctuations which cannot be reasonably foreseen. A previous performance is not necessarily indicative of future results. Neither Rizzo Farrugia, nor any of its directors or employees accept any responsibility for any loss or damage resulting from the use of all or part of it and no representation or warranty is given with respect to reliability. of the information contained in this report.

© 2020 Rizzo, Farrugia & Co. (Stockbrokers) Ltd. All rights reserved.

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