The US dollar ends 2020 in a downtrend momentum against major currencies as investors move away from the safety of the greenback, betting on the global economic recovery in 2021 and the continued US fiscal and monetary policies. 

The DXY-dollar index against a basket of six major currencies stood at 89.60 on Thursday, having hit its lowest since April 2018. The Euro trades near $1.23 while Pound Sterling advances near $1.3650, hitting their highest levels in 2.5 years against the US dollar, gaining support after Britain and European Union reached a post-Brexit trade deal agreement on Dec.24.

Furthermore, the Euro currency receives more demand vs dollar, since the Eurozone economy runs a huge current account surplus, thanks to exports of Germany and other industrial EU countries, while the US economy has a 12-year record current account deficit which causes further weakness to US dollar.

The greenback’s devaluation continued this week after the US President Donald Trump signed the well-expected $900 billion coronavirus aid package and spending bill on Sunday, to help reduce the damage of the pandemic in the world’s largest economy.

The fresh US stimulus bills are dollar-negative catalysts since they grow the nation’s budget deficit, increase the inflationary pressure in the economy (higher commodity prices), resulting in a real dilution of greenback’s purchasing value.

Safe havens under pressure:

The “safe-haven” currencies US dollar, Japanese Yen, and Swiss Franc have been under pressure against riskier currencies such as the Euro, Pound Sterling, and the dollars of Canada, Australia, and New Zealand in the second half of 2020.

The combination of massive fiscal and monetary policies around the world, the approval of the US stimulus bill, the start of mass vaccination programs in Europe and the USA, the relief over the well-awaited Brexit deal have bolstered risk appetite sentiment and created a positive backdrop for riskier currencies and global equities going into 2021.

The trade-sensitive Canadian, Australian, New Zealand dollars, and Asian currencies have climbed to the highest level in 2 years against the greenback amid the hopes that the rollout of Covid vaccines would end the widespread lockdowns and bring an economic normalisation next year.

Hence, the commodity-sensitive Mexican Peso, Norwegian Krone, and Russian Rubble hit yearly highs against the US dollar amid the tremendous rally in the commodity sector led by Crude oil and industrial metals (Copper, Iron Ore).

The trade & commodity-sensitive currencies are considered barometers of the risk appetite sentiment among market participants because of their trade ties with China and global commerce.

2021 US dollar Outlook:

The weaker demand for the US dollar is expected to remain in 2021 if the Federal Reserve keeps its loose monetary policy and interest rates near zero. Also, the new elected President Joe Biden is expected to push more economic support measures (extends current fiscal packages) since the second wave of pandemic and the resumption of social restrictions have become a real threat to the US economy.

The UK assets opened the week with significant losses on concerns over a fast-spreading coronavirus strain in the country and little progress on a post-Brexit trade deal. 

The FTSE 100 Index tumbled as much as 3% on Monday as UK travel, airline, and retail shares were among the worst hit. Pound Sterling lost more than 2% against major currencies, the biggest drop since October, as investors moved to more safe-haven currencies.

The new variant that emerged in southeast England in September, is causing concerns as it is reported to be as 70% more transmissible than other strains and may be contributing to a spike in cases in the country, However, health experts said that Pfizer’s and Moderna’s vaccines would likely be effective against the new variant.

Prime Minister Boris Johnson announced emergency lockdowns in London and other regions over Christmas to curb the spread of the new strain, while several countries banned flights and suspended rail links with the UK.

The uncertainty about the new variant, together with the resumed lockdowns and travel bans have dampened the mood for UK economic prospects, as there is a growing fear that the virus situation will remain on course at least through Q1 2021.

The European Central Bank (ECB) eased its policy once again on Thursday by increasing the overall size of its Pandemic Emergency Purchase Program (PEPP) by €500 billion to a total of €1,850 billion.

The main goal of the Central Bank is to help the Eurozone economy to manage the new implications of the second wave of the pandemic, while it also lowered its EU growth forecast and inflation rates for 2021.

The ECB surprised the market by extending the quantitative easing (QE) program by 9 months to March 2022, to keep government and corporate borrowing costs at record lows. The Central Bank decided to leave its benchmark interest rates unchanged at record lows of -0.50% while the main refinancing rate is unchanged at 0%.

In the post-meeting press conference, the ECB President Christine Lagarde said that the bank is monitoring the euro “very carefully”, while the increase in PEPP reflects fallout in economic activity.

Among other positive developments for the Eurozone, EU leaders in Brussels seemed close to unblocking a stalled 1.8 trillion euro package to help revive their pandemic-ravaged economies, after Poland and Hungary opposed the package.

Market Reaction:

When a Central Bank prints money, it usually causes a devaluation of its currency. However, this is not the case for Euro as investors see the ECB actions with a positive-supporting view. The common currency jumped by 50 points to a session high at $1.2150 after the ECB announcement on Thursday afternoon together with the US dollar weakness and declining Covid-19 infections in the EU.

The common currency received additional support on the downward pressure to the US dollar following the unexpected large surge in U.S Initial Weekly Jobless Claims. The number of Americans filing for unemployment-related benefits jumped to 853K during the week ending Dec. 5, up sharply from the previous month’s upwardly revised reading of 716K. This is the highest level since Sept. 19 and reflects the effects of recent pandemic-related restrictions or lockdowns in some States.

Brexit talks stalled:

The latest developments from the Brexit front have stalled the rise of the Euro beyond 1.2150, as the talks between European Commission President Ursula von der Leyen and U.K. Prime Minister Boris Johnson at the beginning of this week have ended without a breakthrough.

British Prime Minister Boris Johnson said on Thursday there was “a strong possibility” Britain and the EU would fail to strike a trade deal. The two teams of negotiators are continuing to meet ahead of the Sunday deadline, with analysts expecting little chance of success without fresh political compromise.

Forex traders are positioning their funds to more risky currencies following the latest vaccine optimism, the growing hopes for more stimulus plans, and the ongoing rally in the global stock markets and commodities.

The risk-on sentiment propelled a reversal investment trend in the forex market, sending investors away from the “safety” currencies and into risky currencies. As a result, the “safe-havens” such as the US dollar, Japanese Yen, and the Swiss Franc experienced significant losses in the past weeks against “risk-sensitive” currencies such as the Euro, Sterling, and the dollars of Australia, New Zealand, and Canada.

The emerging markets and the exporting-focus economies will be benefited the most from the expected reopening of the global market and trade environment in a “Covid-free” 2021.

US dollar slides to 2 years low

The DXY which is the US dollar index against a basket of major currencies broke below 91 levels on Thursday for the first time since April 2018 amid expectations for an agreement on fresh relief pandemic-related stimulus package for the US economy and hopes for mass vaccinations.

The US dollar lost ground on the hopes that the US legislators will soon reach an agreement of a $908 billion stimulus bill, despite the current disagreement between the Democrats and Republicans in Congress. The new package will create more inflation pressure which is against the value of the US dollar.

Also, the greenback received more pressure yesterday amid the growing worries for the current situation in the US economy after the disappointing US job numbers for November together with the rising infection numbers which forced some States to re-introduce some restriction measures to control the disease.

Mass vaccination boosted risky currencies

The appetite for risky currencies boosted on Wednesday after Britain became the first country in the world to approve a Covid-19 vaccine developed by the group of Pfizer/BioNTech. British top health officials confirmed that they would start vaccinating those groups of people with the most risk as soon as early next week. European Union and US health authorities are due to approve both vaccines from Moderna and Pfizer in the next two weeks, starting also the first vaccinations by year-end.

The recent weakness in the US dollar, the promise of the Federal Reserve to keep the interest rates low for a longer time, together with the vaccine-led risk appetite have helped all the risk-sensitive currencies to climb at multi-year highs.

Euro broke above the psychological level of $1.20 for the first time after 2.5 years, supported by the stronger Eurozone macroeconomic figures and decreasing Covid infections, while the British Pound rose to $1.35, a three-month high. Both currencies have also received support from the progress on the Brexit negotiations with the hopes for a trade deal by end of 2020.

The commodity currencies Australia, New Zealand, and Canadian dollars have also climbed to their strongest level in 2 years versus the US dollar, supported by the weakness of the greenback, the economic rebound in China, and the recent rally in commodities (Copper, Crude oil, Silver, Grains Industrial metals).

The Turkish lira weakened to a record low of 8.32 against the US dollar and 9.77 against the Euro on Thursday morning, heading further into uncharted territories. The Lira lost more than 27% of its value in 2020 and almost 90% since the financial crisis of 2008 against major currencies and shows little sign of stabilising despite the efforts by its Central Bank to stop the fall.

The sell-off in Turkey’s currency was driven by a cocktail of worries such as the worsened inflation outlook, the unwillingness of Central Bank and President Erdogan to increase the key policy rates above inflation rates, the badly depleted FX reserves, poor macroeconomic fundamentals, ongoing geopolitical tensions in the Caucasus and the Eastern Mediterranean, deterioration of Turkey’s relations with Western allies and the prospect of economic sanctions under a possible Joe Biden presidency.

Central Bank and Inflation risks:

The USD/TRY broke above the symbolic level of 8 for the first time ever, adding additional inflation pressure, just after Turkey’s Central Bank kept unchanged its policy rate at 10.25% last week, saying significant tightening in financial conditions had already been achieved after steps to contain inflation risks.

The Turkish Central Bank has also raised its mid-point inflation forecast for end-2020 to 12.1% from 8.9% in its previous inflation report in September, while the bank forecasts that inflation will fall to 9.4% at the end of 2021, compared with a forecast of 6.2%.

The decision of the Central Bank to leave the key rate at 10.25% has disappointed investors who had expected a big interest rate hike of 175 basis points to support the falling lira. Investors were expecting more monetary tightening after the surprised 200 basis points rate hike in September (first rate hike after 2018) to control Turkey’s chronically high inflation.

President Erdogan had long called for interest rates to be lowered, describing them as the “mother and father of all evil”, raising the concerns about the Central Bank’s independence and fears over presidential control on monetary and economic policies. Erdogan fired the previous central bank chief Murat Cetinkaya in 2019, who resisted the president’s growth-at-all-costs policy and low-interest rates.

The current key policy rate of 10.25% remains below the annual consumer price inflation, which stood at 11.75% in September, leaving real rates negative for the lira. This development forces Turkey’s lira depositors to sell their currency for the more stable US dollar, Euro, or Gold, adding more pressure to the lira.

Turkish retail and government banks have spent more than $135 billion over the past 2 years to support the falling lira in the open market, worsening the country’s foreign currency reserves. Moody’s Analytics has warned that Turkey has almost depleted the buffers that would allow it to stave off a potential balance-of-payments crisis.

Geopolitical Tensions:

The growing geopolitical tensions have further depreciated the lira and weakened the country’s economic conditions. President Recep Tayyip Erdogan has recently opened personal disputes with France’s president Emmanuel Macron in response to some controversial comments about Islam. Furthermore, France recalled its ambassador to Ankara after Mr. Erdogan said that Emmanuel Macron needed mental treatment and called Turks to boycott French goods.

The investment sentiment about Turkey’s lira deteriorated after European Council President Charles Michel accused Turkey of resorting to provocations, unilateral actions in the Eastern Mediterranean, and Caucasus and insultations against European leaders.

Turkey has been accused of its role in the re-eruption of fighting in the disputed Caucasus region of Nagorno-Karabakh between Azerbaijan and Armenia. Furthermore, it has an ongoing dispute with Greece and Cyprus over maritime rights and ownership of natural resources while it has supplied weapons and soldiers to support its proxy groups into Libyan and Syrian civil wars.

US elections add pressure on Turkey’s lira:

The relation between Turkey and the USA has deteriorated after Turkey had started testing a Russian-made S-400 air defense system, while it also antagonizes the US in the Middle East and the Mediterranean Sea with its aggressive foreign policy. The Turkish lira slid further this week after President Erdogan challenged the United States to slap sanctions over his government’s decision to test the S-400 missiles.

Forex traders fear that a win for the Democratic candidate Joe Biden in the US presidential election of November 03, could increase the likelihood of economic sanctions against Turkey. Joe Biden has recently referred to President Erdogan as an autocrat and stated he was in favor of supporting political opponents to defeat him in elections.

Investors believe that a Biden administration would work with European allies to impose extra aggressive sanctions against Turkey into 2021. The last time the US imposed sanctions against Turkey was in 2018 when Turkey imprisoned U.S. pastor Andrew Brunson on terrorism charges, sparking a currency crisis for the lira that led to a deep recession in the Turkish economy.

Turkish Economy:

Turkey’s economy contracted nearly 10% in the second quarter of 2020 as it was significantly affected by the coronavirus pandemic and measures to combat it. The local retail market was hit hard from the lower consumption combined with the Lira’s depreciation and higher inflation rates. In addition, the lira sell-off comes as Turkey earns fewer dollars and euros due to a massive drop in tourism and slumping exports amid the virus pandemic.

Given the ongoing uncertainties around the economy, the pandemic, and geopolitical tensions, Fitch ratings expect the Turkish economy to remain volatile, forecasting the GDP to contract by 3.2% in 2020, but grow more than 5.0% in 2021.

Rating houses downgrade Turkish companies:

Many rating houses have already started downgrading the outlook for the Turkish companies amid the depreciation of the Turkish lira, the fragile local economy, and the weak corporate revenues from the effects of the Covid-19 pandemic.

The downgrades reflect mainly the material foreign currency risk as most of the Turkish companies have large debts denominated in US dollars (loans) or Euros (Eurobonds), but their corporate revenues are in Turkish lira. The heightened FX exposure has weakened the credit metrics of the companies while some of them have already been facing difficulties to meet their debt obligations.