USD Continues To Get Weighed Down

Foreign Exchange Markets

Through the lens of US asset market outperformance, a consensus view into 2021 is that the US dollar is overvalued after a long stretch of American exceptionalism. The Fed rate cuts have eroded the US dollar carry advantage, while their new average inflation targeting framework should keep (real and nominal) interest rates low for several years. Simultaneously, a recovering global economy should weigh on the “safe-haven” dollar demand through various channels like higher stocks and commodity prices.


The pound is trading firmer in Asia taking a cue from the FTSE 100 futures racing higher possibly positioning for post-Brexit in-flows. And even some year-end window dressing as this week should bring greater visibility in financial institutions’ balance sheet limits with both the Brexit and the US stimulus deal in the rear-view mirror. 


Everyone wants to own euros heading into 2021 as the currency stands to get support from favorable valuations. Investors may look to tap into European equities, for example, which are cheap and under-owned. Extensive fiscal and monetary policy supports in the US that seem set to continue, spilling over to the rest of the world in the form of wider twin deficits, should fuel a weaker dollar by encouraging US corporates and investors to pursue enhanced returns abroad. And then there is the compression of risk premium in Europe driven by the ECB’s PEPP program, which was extended and kept peripheral spreads tight.

Year-end could be holding G-5 FX risk back.

But holding currency risk back is the December/January turns are actively trading as spot/next funding, except JPY as tom/next kicks in. With cash markets shifting to fuller liquidity mode after the extra-long weekend, G5 turns are about 200bp tighter vs Christmas eve on the firm rebound in funding as “The Streets ” FX year-end roll requirement seems a lot more certain after the Christmas holidays. 

There is no clear driver for USD funding stress as the Dec 28 sizable UST coupon settlement got past smoothly – the general collateral repo rate saw a high of only 0.12% – and the New York Fed’s repo operations facility remains untapped. 

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