Has 2021 changed the course of wind for Dollar or it’s merely a passing breeze?

2021 seems to have begun with another bang for the US politics with democrats taking full control of both, the US Senate and the House of Representatives, under the Biden Presidency following the win in the Georgia runoffs. The same has flipped the scenario of the financial markets as we see an immediate rise in the US dollar, a spike in the 10 Year bond Yields as well a surge in the equities.

What does it mean for the US treasury yields and the US Dollar?

Total control over both the houses of the US would make legislation easier to pass and increases the prospects of stimulus coupled with additional easing measures and under the Democrats rule. The US 10 year treasury yields shot up to 10 months high at 1.19 percent due to expectations of further borrowing by the US treasury. This move was further accelerated after the US President-elect Joe Biden said Americans need more economic relief now and that he will deliver a plan costing ‘trillions’ of dollars next week after the recent payrolls data showed the US economy lost jobs for the first time in December since April as a resurgence in the Covid-19 pandemic led to shuttering of many businesses.

Biden called for raising the minimum wage to $15, and for sending out $2,000 in direct cash payments, those which were sought in the last relief bill, passed in December, but only were able to get Republicans to agree to $600. These expectations of further fiscal easing lead to a rise in the inflation expectations that are at 2.10 percent and have been already soring due to a jump in the crude oil prices. Increased inflationary expectations despite rise in the bond yields have kept the US real rates negative, which going further can keep the dollar on a weaker trajectory in the medium to long run. However, in the near term, rise in the treasury yields triggered US Dollar index to shot from nearly three years low to 90.50 levels as it helped charge the unwinding of sell bets on the currency with traders taking profits against the majors like Euro, Pound and Japanese Yen. The rally also extended after Federal Reserve Vice Chairman said he expects the central bank to maintain the pace of its asset purchases worth $120 billion per month through the balance of 2021.

Currently, the sentiments are speaking that the investors are not looking at the ballooning of debt led by the increase in the monetary assistance or have seemed to be discounted the same, which was the reason why the dollar kept declining throughout until now. Hence, when the stimulus will actually be announced, might not aggravate the downward pressure on the dollar substantially. Well, for now, it seems like the rally could be short-lived and extend close to 91.00 levels due to a spike in the bond yields, increased inflation projections and correction in the majors like Euro and Pound.

Dollar taking advantage of Correction in the Majors

Euro began plunging after traders rushed for profit-taking near 1.2350 levels in the last week after Europe closed its borders to the UK. There are signs that the new strain of coronavirus has already been found in multiple locations in Europe, though in smaller numbers than in the UK. This can take a toll on the business activity that had just begun to revive.

Whereas for Pound, demand has been eroding by covid developments in the UK, as, despite the tough lockdown announced late in December, the number of new cases keeps increasing, and jeopardizing the health systems. On the data front, the focus will be on BOE’s Governor Andrew Bailey speech who has already warned that Brexit would mean a 4 percent on GDP in the long-term. However, anticipating chances of negative rates in the kingdom, amid the double hit from Brexit and covid further weighed on GBP.

Also, technically the daily chart shows that the near-term trend is on the upside with a resistance around 91 levels which is at the upper Bollinger band. However, a breakout above the same could be a hint to the reversal of the trend.

Conclusion:

Looking at the current twist in the scenario, it is too early to comment that the long term trend for the dollar has reversed for bullish until the confirmation occurs and sustainability is gauged looking the price action for the next few sessions as the index has trapped the traders in the past with a false rally as well as breakouts. However, the correction in the near term is likely to extend up till 91.00 levels a breakout above which shall determine the medium to long term correction.

-Amit Pabari is managing director of CR Forex Advisors. The views expressed are personal.