FX comment

Fiscal policy remains the primary response to Covid19 crisis, with central banks expected to continue to cooperate with additional QE over the coming quarters (see first chart). For currencies the impact of such a policy mix may be unstable over time, with BoP trends likely the swing factor.

As fiscal expansion meets a (largely forced) rise in private sector savings, it has had little impact on current account balances. For instance, in Australia and Sweden, the current account balance even improved this year. Beyond the impact of recession depressing imports, export specialisation proves to be key. We see BoP shifts as a more lasting positive for AUD, SEK than CAD, GBP (see second chart). The turnaround in the current account balance in Australia indeed owes much to increasing commodity exports alongside Chinese recovery.

Contrary to the 2008 financial crisis, global imbalances have widened so far instead of reducing (the increase in Chinese current account surplus contrasts with a widening in US current account deficit). This should matter for currency volatility.

The sharp widening in developed market budget deficits in 2020 gives way to 2 challenges for governments in 2021: how to deal with fiscal cliffs as temporary measures roll off and how to shift from emergency measures to more targeted, strategic support to the economy, in order to prevent scarring effects (eg. structural unemployment, lower potential growth). Despite results of US elections being delayed, markets expect that the next US administration will address the first challenge, likely to lead to wider twin deficits in 2021 amid Fed’s accommodative policy, a drag for the USD in our view. But how the US deals with the second challenge remains unknown and will likely be key for longer-term outlook of the USD.

graph fx comment

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