Is your currency strategy ready for 2021?

What will 2021 bring for the currency markets? Quite a few business owners and investors are only too eager to know the answer to this question. We put it to George Vessey, senior analyst at Western Union Business Solutions, one of the partners come to bolster the exchange rate service of Isabel 6 since last year.

A great deal will depend on how the COVID-19 pandemic evolves in 2021, of course.  It seems almost certain that it will still be part of our daily lives.  Fortunately, it is also certain that the introduction of vaccines will be an important catalyst for better prospects.

At the same time, the speed and efficiency with which that vaccination is rolled out will be the ultimate key to the recovery of our economy. Unfortunately, the virus is not going away on its own. And until we get the available vaccines distributed to a sufficiently large proportion of the population (70%), economic recovery is also in danger of lagging behind or even failing altogether.  

Economic recovery

Meanwhile, the good news is that the world’s economic fabric has been largely preserved. We can therefore revitalize it quickly also. All eyes are turned on the consumer first and foremost on this front. In many advanced economies, household savings reached record levels last year in fact. So it is hoped that this pent-up demand will accelerate growth through consumption in the latter part of this year.

In anticipation of this renewed growth, the financial markets have already reacted positively to the news of vaccinations in recent months. Nevertheless, the economic situation clearly remains precarious. The emergence of several variants of the coronavirus could undermine the expected recovery scenario significantly, especially if these variants prove to be more contagious or more resistant to existing vaccines.

Shifting demand for currencies

The IMF also sees economic growth increasing in the second half of this year, but it is taking due account of an incomplete and uneven recovery. The latter is particularly interesting from a currency perspective. Currencies will actually be sensitive in 2021, not only to market sentiment about the global outlook, but also to differences in the pace of recovery between countries or regions. 

Expectations that a country or region’s economy will recover quickly could cause shifts in demand for currencies this year. And it should come as no surprise to anyone that a successful vaccine rollout can have a major impact on that recovery expectation. For example, the success of the British vaccination campaign partly explains why the pound is performing better today against the euro but especially against the US dollar. This latter currency is in turn fighting back against the other currencies, also driven by a remarkably smooth vaccine rollout. Conversely, the vaccine backlog experienced by Europe and Japan in recent months is clearly not helping the valuation of their currencies.

The euro versus the dollar and the pound

Whereas the IMF raised the global growth forecast for 2021, it lowered the economic outlook for Europe and the UK, while it then raised the US recovery forecast. China’s economy is also expected to continue its strongest recovery in 2021.  

Nevertheless, the prevailing market consensus is that the euro will continue to outperform the dollar in 2021, thanks to a strong economic recovery in the eurozone, a rising stock market and weak market sentiment toward a double-dip deficit in the US. A shift in that market sentiment, an increase in market risks and new political discord in Europe could reverse the current scenario. Furthermore, the rate of growth in the US has traditionally been stronger, which means that once growth has started there, demand for the US dollar will increase rapidly.

Concerns about Brexit continued to play tricks on the British pound until late last year, when the EU and the UK finally reached an agreement. At a historically low value against the euro, the pound began an ascent early this year that brought the currency to its highest level in eight months in mid-February. The fact that the UK was leading the vaccine race all along obviously helped. Whether the British pound will be able to catch up further with the euro nonetheless will also depend on the UK’s economic recovery. And that, as always with forecasts of this kind, is highly uncertain.

In essence, it all boils down to having a currency strategy and stress testing it regularly. This is the only way to manage exchange rate volatility to a certain degree and to limit your currency risks.

View George Vessey’s full, detailed exchange rate analysis here.