United States Dollar (USD) is the most powerful and most traded currency in the world. The reputation does not end there; it is the world’s largest economy making USD a key icon of the global economy. Moreover, USD is also held by the leading financial institutions to undertake international transactions.
In 2020, when COVID-19 virus wreaked havoc all over the world, it crippled global economies. US has been at the forefront of the impact, leading in the number of cases and deaths. US Presidential elections also had a sharp effect on the US Dollar.
The pressure on the USD is strong. In 2021, what would be the fate of the world’s reserve currency? After plunging through much of 2020, there are several factors that could either strengthen or weaken the USD in 2021.
Here are five factors affecting the USD in 2021.
5 Factors Affecting the USD
- Federal Reserve Policy in 2021
- Recovery From the Pandemic
- US Fiscal Stimulus
- Global Trade Relations
- European Central Bank Action
Federal Reserve Policy in 2021
The role of the Federal Reserve, the world’s most powerful central bank, in buying dollars and selling foreign currency, and vice versa, is not going to change. Federal Reserve has given indications that they would hold the rates near zero through to at-least 2023 and keep buying bonds to support the US economy through this challenging time.
Federal Reserve is purchasing at least $120 billion a month and is ready to ramp it up if necessary. Contrary to reactions in the UK and the Eurozone, this has resulted in a straightforward devaluation of the dollar.
The bank’s rates and QE commitments are not going to remain constant forever. The Fed’s policy review in 2020 wanted to achieve maximum employment and price stability, even welcoming signs of price rises that reflected a growing economy and also compensating for stagnant inflation in previous years.
In 2020, with the pandemic hovering over the economy, prices advanced too quickly. The crisis caused supply to close down due to the lack of demand. Once, everything is on track and people get back to their normal lives, the financial situation is will improve, increasing the consumption rate. Under such circumstances, demand may exceed supply and lead to short-term increases in prices.
Due to de-globalisation, long-term inflation is going to be on the rise. The pandemic has shown that instead of relying on cheap imports, there is a need to support and source products locally.
To combat price rises, the Federal Reserve could increase the interest rates; this will strengthen the dollar.
Though the Federal Reserve is not likely to increase the rates when hit with inflation, it could withdraw bond-buying or move rates higher in 2022. Any indication that the Feds are being stricter on monetary policies could hassle the currency markets.
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Recovery From the Pandemic
The stop-start pace of vaccine rollouts around the world has had a different effect on different currencies. The sentiments behind vaccine hopes have boosted the euro, but the dollar has dipped.
Most of the European Union countries and the UK saw accelerating vaccination campaigns in the first quarter of 2021. The progress offset elevated case rates enough to propel the pound higher and providing hope that things will be back to normal soon. As the US deals with infections and faltering vaccination rates, the dollar could continue its descent.
However, scientists worry that the vaccines might be ineffective with mutations. This may force researchers to start from scratch and remake their inoculations. Any delay in solving medical issues would slow the recovery. As fears mount of a second or third coronavirus wave, investors may flee to one of the safest assets on the market – the USD.
US Fiscal Stimulus
In December 2020, a month before he left office, former US President Donald Trump had signed a stimulus bill into law, releasing $900 billion in emergency relief funds. In January 2021, President Joe Biden signed a $1.9 trillion stimulus package that will also include unemployment benefits, vaccine programs, and funds for local officers to fight the virus.
What do staggering amounts of this size mean for the US Dollar? Apart from the aid, insurance supplements and benefits, the fiscal package could lift the collapsing infrastructure of the US economy and mitigate the pain caused by a year of economic restrictions. Even though there are signs that the US economy is starting to improve, the abundance of both monetary and fiscal stimulus had a negative effect on the US Dollar index.
Global Trade Relations
United States and China are the most important players in the global economy (both countries combined account for around 40% of the global economic activity). Trade and tech relations between China and the US have been strained for the last few years. A hostile trade war under the former President Donald Trump saw tariffs placed on a range of goods traded between these massive economies. In 2020, US and China clashed over the transparency regarding the origin of the COVID-19 virus.
With President Biden taking charge, are the tensions going to deepen or decline? The world’s largest economies still depend heavily on each other, and the occasional truce would weigh on the USD.
Additional sanctions against Chinese companies may send investors to the safety of the US dollar. If the current trade disputes are not settled under the rules of commerce established under World Trade Organisation (WTO), Sino-American tensions will probably be a positive factor for the dollar in 2021.
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European Central Bank Action
US central banking system, when compared to the European Central Bank (ECB) is more powerful. However, the ECB has a growing influence on the dollar. ECB put forward an emergency bond-buying program to deal with the economic shock from the pandemic.
1.35 trillion euros used to expand the ECB’s Pandemic Emergency Purchase Program (PEPP). This has been supporting the euro and the euro zone economy through the coronavirus crisis. This is pushing the euro higher contributing to the weakness of the dollar.
The ECB may let its program lapse in early 2022, thus weighing on the euro and supporting the dollar. Moreover, the bank may further cut its deposit rate below -0.50% – a move that would depress the currency.
After a bad phase through much of 2020, several factors could positively affect the USD through 2021.
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