Signs are showing that the weak US dollar is poised to rebound this year. Bank of America strategists led by Athanasios Vamvakidis boosted their forecast for the US currency on Tuesday. They expect the currently weak US dollar to grow stronger and trade 1.15 dollars to 1 euro by the end of 2021. Meanwhile Wall Street forecast the exchange rate to grow even higher at $1.25:€1.
A stronger euro/weaker US dollar rate means a weaker US currency. Right now, the euro trades at 1.20, which is 3 cents lower than the start of the year. Bank of America expects the greenback to rise, but now they see it happening sooner than later. Bank of America gave five reasons the dollar will strengthen sooner.
The Gap Between the Federal Reserve and the European Central Bank
After pumping billions of dollars into the economy last year, the Federal Reserve is winding down on its easy policy stance. Some officials want the Fed to go easy on asset purchases. However, the Fed denied premature tightening, but mixed communication is showing signs of policy normalization as early as next year.
Meanwhile, the European Central Bank is weathering intense rhetoric against Euro strength in recent weeks. An upcoming strategic review of how the ECB can achieve its inflation target will show its strategy. “The bottom line is that the ECB will be moving towards more easing, while the Fed will be looking towards policy normalization,” the BofA said.
Incoming Stimulus Boost
The Biden administration is pulling out all the stops in pushing to pass its $1.9 trillion stimulus package, the American Rescue Plan. By using the reconciliation process, Democrats in Congress won’t need a majority to get the bill passed. The dollar will definitely take a hit with such a large amount flooding the market. In addition, it also increases the risk of earlier policy normalization by the Fed. Long term, the stimulus package should boost the dollar's strength.
Across the pond, European Union fiscal policy is “not as supportive and if anything could be tightened too early,” the team said.
With widespread vaccination happening all across the world, the global economy expects to rebound within the year. Still, Bank of America expects US growth to beat the EU’s pace easily.
BofA projects US growth of 6% in 2021 and 4.5% in 2021. Meanwhile, they see the EU grow by 2.9% this year and 3.4% next year. In addition, US inflation projects to come in above EU price growth. The US decoupling from the EU in terms of the economy should support the dollar going stronger.
Shorting the Dollar
Outside of meme stocks, the US dollar could also face a massive short squeeze. Despite the currency’s recent rally, the market continues to short the dollar. If projections are correct and the US economy outpaces the EU’s, the euro-dollar trade will likely cut into long positions and strengthen the dollar, the strategists said.
A reversal from the risk-on party that pushed stocks is about to happen, which will push investors into holding on to cash positions. Bank of America expects risk assets positioning to peak by the first quarter. They also expect limits to policy support the following quarter. Analysts expect a 10% market correction sometime this year and dampen investor demand for stocks.
Assets already at record highs will leave little space for more upside. The vaccination’s slow pace will take years to complete. The long path to recovery should push the dollar upwards in the near term, according to Bank of America. “A more challenging outlook for risk assets this year also suggests a less clear foreign-exchange picture and upside USD risks,” BofA strategists said.
Watch the Wall Street Journal video special on Why the U.S. Dollar Remains Strong:
Do you agree that the weak US dollar will get stronger later? Or, do you think the dollar will remain weaker due to outside pressure such as stimulus money flooding the market? Let us know what you think. Share your opinions in the comment section below.