Fixed Income Outlook  |  Q1 2021

Currency views

Fixed Income Team

Currency views

U.S. dollar likely to remain weak

The dollar's support from its high-yielding status has disappeared as the Fed slashed rates to zero. The central bank's new policy framework means a lower-for-longer short-term policy rate and continued asset purchases until there is "substantial further progress" on its employment and inflation goals. Despite optimism on vaccines and the sizeable pandemic relief package, these goals still look to be more than a year out and should keep real yields low (and potentially lower) in the United States. As such, the dollar will likely remain weak.

Euro to trend higher amid global recovery

Europe looks set to see a double-dip recession in the fourth quarter after better-than-expected growth in the third quarter as some countries reintroduce lockdowns. The ECB has voiced concern over the anticipated slowdown and has increased asset purchases. The European Recovery Fund remains a fundamental game changer for the eurozone over the medium to long term. This and the ECB's asset purchases should keep bond spreads tighter in peripheral countries, ensuring loose monetary policy across the region. The euro's valuation is no longer as appealing, but it is not a deterrent. As such, we expect the euro to trend higher against the dollar as the global economy recovers.

Upside for pound over the medium term

The U.K. parliament has approved the post-Brexit trade agreement with the European Union (EU). It is pending final EU implementation. Although the trade deal appears to be quite thin, it is better than no deal, and any remaining risk premium for a no-deal outcome can be priced out. Amid a virus resurgence, new lockdowns, and potential trade frictions with the EU, we expect some short-term economic pain. Still, we believe the U.K. is positioned well for a domestic and global recovery, fueled by vaccine news and vaccinations this year. There will be near-term risks and medium-term upside for sterling in our view.

Japan's yen likely to appreciate

The Bank of Japan (BoJ) remains largely sidelined with limits on further monetary policy easing. It is focused on ensuring bond yields remain low and inflation hits its 2% target. The BoJ said in December it will look at ways to make its policy more effective and sustainable in April. Policymakers are likely to fine-tune their market operations and asset purchases. With higher real rates in Japan, short-term rates make buying of hedged foreign bonds more attractive than unhedged purchases. As purchases of foreign equity abates and outward direct investment from Japan slows, we should see a stronger yen.

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Global financial markets trended higher during the fourth quarter, powered by the emergence of COVID-19 vaccines and continuing stimulus policies.