The Haves and Have Nots of the Pandemic Recovery
There has been much discussion lately of “US exceptionalism”, the idea that the strength of the US economy in the post-pandemic boom significantly exceeds that of the rest of the world and is leading to a resurgence of the US dollar. In reality, there is a strong argument that if you’re looking for countries that are in exceptional positions, it is not only the US, but also its neighbours Canada and Mexico, that fit that description.
Canada and Mexico are next to a country that is injecting fiscal stimulus worth more than 10% of GDP, one with which they have very tight trade relationships, and one that is projected to grow rapidly this year. So, Mexico and Canada are in effect receiving huge stimulus for free, without the debt burden, making their currencies an attractive buy.
Other advanced economies are in less enviable positions. The IMF sees much faster GDP growth this year in the US (6.4%) than it does in European countries such as Germany (3.6%) and Italy (4.2%).1 This reflects the scale of US stimulus and the speed of its vaccination rollout, in contrast to the supply-constrained European Union. France is experiencing a third wave of COVID-19 and has plunged into a new lockdown.2
The dollar direction
Standard Chartered takes the view that while the US dollar’s current strength has the appearance of exceptionalism, this will soon fade away. Fed policymakers have noted that the Phillips curve (which typically shows an inverse relationship between inflation and unemployment) and the labour supply curve are flat, and in that context, they see little reason to push policy rates higher. Nor do they seem overly concerned, for now, about inflation straying too far above their 2% target this year.
Policymakers thus have little reason to expect foreigners to keep buying US debt indefinitely. For the past six years, central banks have been selling dollars. The US external imbalances will get larger, and the returns from holding dollars are becoming less attractive. This is a formula for a weak US currency. Once the market has priced in the strength of the coming re-opening, the vaccination drive and the recovery, it will likely be downhill for the dollar.
Looking east – North Asia leading forex recovery
A second reason to challenge the “US exceptionalism” theory is that the US is by no means the only major economy set for strong growth this year. Indeed, it is Asia that has led the global recovery, China in particular. Uniquely among major economies, China’s economy was larger at the end of pandemic-stricken 2020 than at the start. Asian currencies have performed well relative to their global peers, and Asia’s fundamentals were strong entering the crisis.
The recovery in global trade has been much faster than after the 2008 Global Financial Crisis, and this has benefited Asia’s open economies, helping some Asian currencies withstand the pressure of the strong US dollar in Q1-2021. Here again, though, the picture is uneven. Asian economies that are highly dependent on tourism have struggled, as have some closed economies, although India is projected to see scorching double-digit growth in 2021.
China and the yuan, one of the strongest currencies against the US dollar this year, have anchored the region’s foreign exchange story. In terms of stimulus, China’s response has been more targeted and sustainable than it was in 2008, which should help it avoid a monetary hangover. The yuan has also proved extremely resilient to trade tensions with the US, which have persisted despite the change of administration in Washington DC.
The yuan’s strength reflects China’s handling of the pandemic, as well as interest-rate differentials with the US and other developed markets. High yields, a stable currency and a strong growing economy constitute a trifecta of qualities that fixed income investors look for, and China’s fixed income markets have been notably stable this year. This bolsters the perception of its stability and the diversification benefits for global investors.
Emerging markets recovery to be led by commodities demand
The combination of huge stimulus, surging demand, inflation fears and the potential for a weak dollar tends to boost one asset class in particular: commodities. Alongside a services boom, the post-pandemic bounce is likely to see a surge in infrastructure investment, including healthcare facilities and climate-change projects, and this will underpin demand for goods and raw materials. For both structural and cyclical reasons, the commodities slack seen from 2010-2020 may not be with us for much longer.
This should support demand for industrial metals such as nickel, aluminium and copper, although precious metals are more complex. Gold is not currently behaving like an inflation hedge, but silver and platinum may benefit from their use in new, greener technologies such as fuel cells.3 And oil has reversed its decline this year after being the laggard of the commodities complex in 2020, to the benefit of oil exporters in the Middle East.
Commodity-linked currencies are still underperforming, however, and will likely go higher as demand picks up. This is likely to be good news for the Australian and Canadian dollars and for many emerging-market currencies – particularly those with strong links to China and the US – in the second half of 2021.
However, as is the case with developed markets, some emerging markets are doing much better than others. The explosion in the size of fiscal deficits has made many economies reliant on central bank financing, raising the risk of debt monetisation; others are heavily exposed to US dollar liabilities and vulnerable to the current strength of the dollar. A weaker dollar would arguably be positive in many respects, sustaining global trade and helping to avoid a “taper tantrum”-style exodus of capital from fragile economies.
Out of sync?
This bifurcation between the “Haves” and “Have Nots” of the COVID recovery is a cause for concern. If some countries recover much more quickly than others, the business cycle will de-synchronise. Monetary and fiscal policy in different countries will start to move in different directions, creating lasting instability in markets.
To avoid this, the Haves have an interest in looking for ways to share their success with the Have Nots, to ensure that the global economy does not suffer its own version of Long COVID.
1 IMF, World Economic Outlook, April 2021: https://www.imf.org/en/Publications/WEO/Issues/2021/03/23/world-economic-outlook-april-2021
2 Financial Times, "Europe’s third wave: ‘It’s spreading fast and it’s spreading everywhere'", 4 April 2021: https://www.ft.com/content/d1af353b-709f-41d5-ac88-4ac38ee7dc6c
3 See Standard Chartered Global Research, Macro Strategy Views, 18 March 2021