A closer look at the US dollar and the British pound
I endeavor to make active investing less complicated. I rarely suggest stock picks but instead try to condense what’s happening in the economy so that our readers may have something to consider as they draw up an investment plan.
The year 2021 appears to be a hopeful one. Reopening borders and businesses are on top of the agenda as businesses and countries are doing their best to roll out COVID-19 vaccines. Most of us hope that this is the year we triumph over the pandemic. So, what should retail investors consider?
The Year Ahead
With reported efficacy of vaccines against the new UK COVID-19 strain, a general upbeat mood that the end to the uncertainties that plagued 2020 is finally in sight. As the new COVID-19 vaccines are gradually delivered and administered worldwide, nations are gradually moving towards pre-COVID normalcy by relaxing border controls and allowing people to return to work. While the rollout of vaccines has been slow, we could be seeing more approvals over the next few months. The easing of border restrictions in several nations has also provided investors with some relief to worries concerning nationwide lockdowns and disruptions.
The economic outlook for the first quarter of 2021 is largely expected to improve as the world gradually returns to normalcy. However, the journey to pre-COVID levels of economic activity is still long and bumpy. With this macroeconomic landscape, let’s take a look at two currencies: the US dollar and the pound sterling.
The Dollar: A Bumpy Start
As we headed into 2021, we saw the dollar extending its decline into January. A contributing factor to this was the anticipation of further US stimulus bills to aid in economic recovery. This has resulted in a boost to the stock market’s risk appetite, in turn putting the safe-haven currency under further pressure. Keeping in mind the persistent trade deficit that we have been witnessing, along with the Fed’s commitment to keeping interest rates near zero until at least through 2023, and the more predictable trade policies under President Biden’s administration, the outlook for the Dollar remains grim.
Firstly, the persistent trade deficit which essentially means that the US is importing much more than it exports will lead to an increased outflow of the USD that would put the currency under considerable pressure. Meanwhile, Biden is expected to announce his economic team, with the nomination of former Fed Chairman Janet Yellen as the treasury secretary, which does little to help boost the USD, given her dovish stance during her tenure. Therefore, with Yellen in charge, we can expect Biden’s Treasury department to echo Fed Chairman Jerome Powell’s policy of a lower-for-longer interest rates view, and a shift towards expansion in government spending.
Elsewhere, the Fed’s commitment to hold interest rates near zero at least until 2023 could result in a shift away from dollardenominated assets to foreign assets that yield higher interest rates which is likely to weaken the USD further. Overall, it would not be surprising to see the USD continue its downtrend in the near future.
Brexit: Crisis Averted
While the US elections have been a headliner over most of the last few months of 2020, Brexit has certainly not fallen off investors’ radar. Brexit has finally become a reality, with the UK formally leaving the European Union’s Single Market and Customs Union
on January 1, 2021. While investors were relieved that a no-deal Brexit was averted, the historic exit from the EU is going to have significant implications for both the UK and the pound sterling.
Fortunately, London and Brussels were able to strike a free-trade agreement with the EU at the last minute, helping to maintain the tariff-free, quota-free status between the UK and EU goods trade. However, the hidden costs of regulatory and border checks have already started rearing its ugly head, hitting hard in certain sectors and resulting in smaller firms likely to be less profitable over time.
However, what the UK managed to salvage in goods trade failed to make up for what it lost in trading services, which accounts for about 40 per cent of total exports to the EU. It is worth noting that the UK has a large services trade surplus with the EU, particularly in financial services. This could mean a dwindling demand for the pound as the UK’s trade relationship with the EU weakens in general, amidst the already poor economic outlook given the ongoing pandemic.
Looking forward, the pound is expected to underperform further into the year, as the UK enters its third lockdown amid rising cases of COVID-19 infections in the country. Moreover, the Monetary Policy Committee of the Bank of England has signalled that negative interest rates are highly likely in the first half of 2021. This is expected to bring further headwinds to the currency if confirmed. However, with vaccinations expected to begin in mid-February, the UK still holds out hope for economic recovery and an improvement in the performance of the pound.
How May We Invest?
With the current low-interest-rate environment and the Federal Reserve’s unlimited treasury purchase plan in effect, the stock market could continue its rally. Although I would be cautious, as it is unlikely that we will see a repeat of the performance seen since March 2020.
The release of the COVID-19 vaccines and the relaxation of border controls have also allowed emerging markets to begin resuming economic activities, providing investors with renewed optimism. Given the current climate, if you have a larger risk appetite, you may consider looking into investing in equities such as the S&P500 or trading positions taking advantage of the potential further weakening of the USD and GBP. Meanwhile, if you are more riskaverse, perhaps if may worth considering safe-haven assets such as Gold in the time being.
Andrew Leong is the COO at Everest Fortune Group, an awardwinning research house and official Singapore FinTech company that provides tailored solutions for brokers, traders, and portfolio managers.