The future of currencies in 2021: 6-month update

2021 - a better-than expected performance so far

15 minute read

The end of last year made for gloomy economic reading: global GDP fell by 4.2% in 2020, a far worse contraction than had occurred during the 2008-09 financial crisis. This downturn, of course, stemmed from the Coronavirus outbreak, the first global pandemic in a century, and the Great Lockdown that followed in April.

2021, on the other hand, has given economic analysts and forecasters reasons to be more sanguine about the state of the world economy, with growth expected to hit 5.8% according to the latest OECD projections. This is markedly higher than the 4.2% increase that was originally predicted by the OECD in December 2020, and it would represent the fastest rate of global economic growth since 1973.

The OECD has attributed this sharp upwards revision to the rollout of vaccines in advanced economies, in addition to the historic fiscal stimulus bills that have been passed in the USA. These bills have aimed to speed the economy recovery without fuelling runaway inflation.

It is worth noting, however, that the economic recovery has proven somewhat uneven so far, with differences in the strength of the recovery being driven by varying levels of government support for businesses and stark gaps between vaccination programs in different countries. Europe could take three years to recover, whilst South Korea and the United States have already succeeded in reaching pre-pandemic income levels.

Whilst the world economy does appear to be recovering from COVID, there is great uncertainty as to how the economy will perform throughout the remainder of this year. There is also no question that the virus will have a profound effect on the global economy’s long-term performance. If the OECD projections for the following year prove to be correct, global income will be $3tn less by the end of 2022 than it would otherwise have been if COVID had never struck.

The OECD has warned that the UK will have the highest rate of inflation (3%) by the end of 2022, the highest rate amongst the advanced economies, which has raised the prospect of a hike in interest rates next year. With inflation at 3.2% and likely to exceed 4%, inflationary pressures appear to be worsening. It’s no wonder that UK stocks have been beset by concerns over rising inflation.

Green shoots of recovery for the UK economy?

With the British government’s vaccination programme well underway, the UK economy has started to show real signs of recovery following a jittery performance at the beginning of this year.

The UK’s first quarter performance this year saw GDP shrink by 1.5%. Whilst this is far from cause for celebration, it is a much smaller contraction than the 4.25% that the Bank of England had predicted in its February report. As in certain other countries, the impact that government restrictions had on spending was not as great as had been anticipated.

Much of the positive economic data can be traced back to the month of March, which saw a limited reopening. Put another way, the green shoots of recovery can, somewhat fittingly, be found in the onset of spring.

In the month of March, construction grew by 5.8%, manufacturing grew 2.1% and production grew by 1.8% in March. March also reported a 4.8% unemployment rate, which marks a 5.1% reduction YoY.

This momentum was sustained in the month that followed. The national payroll grew by almost 100,000 between March and April, the biggest monthly increase in jobs is almost six years, as non-essential retail and leisure facilities started reopening from April 12. The UK grew by 2.3% in April, the fastest monthly growth since July 2020, thanks to the continued easing of lockdown measures. Whilst April’s GDP was 3.7% below the pre-pandemic levels recorded in February 2020, it was also 1.2% above its initial recovery peak in October 2020.

The Bank of England expects that the UK’s GDP will increase by 4.25% in the second quarter of 2021 as increasing numbers of people are vaccinated and restrictions continue to ease. The OECD predicts UK GDP growth of 7.2% in 2021, up from its previous forecast of 5.3%.

The positive sentiments reported in mid-2021 have been dampened somewhat, however, by recent events: in September, Britain was reported to be short of 100,000 lorry drivers, with energy firms struggling to stay afloat and food items running scarce. The moral of this story? Never get complacent over the state of the economy.

The US economy has rebounded – here’s why

Whilst we’re on the subject of good news, the United States has seen its highest rate of growth (6.8%) in more than 35 years. This rate of growth is due in large part to the impact of i) $600 federal stimulus cheques and ii) the mass vaccination rollout. Let’s take a closer look at each of these measures and the role that they have played.

The stimulus cheques that were sent out in January comprised $600 per individual, or $1,200 per married couple filing jointly. Much like the $1,200 cheques that were sent to millions of Americans in the spring of 2020, the second round of cheques were based on household income.

These cheques helped drive a 10% increase in personal income in January, and household wealth rose by nearly $2tn in the same month. Spending, however, increased by just 2.4% ($340.9bn).

The rollout of another wave of monthly government cheques to families with children is due to launch on July 15. This will be worth more than $100bn and should further boost spending in the latter half of 2021.

The US Centres for Disease Control and Prevention reported that 167,157,043 people, or about half of all Americans, had received at least one dose, while 134,418,748 people had been fully vaccinated as of May 29, 2021. This success in vaccinating the American population is widely credited with helping restore a degree of normality to the labour market, which has gone from strength to strength thus far this year.

According to Steve Rick of CUNA Mutual Group, mass vaccination will mean that ‘more permanent, widespread reopening can occur across the board and really start to work to right the ship of the economy.’

It seems very likely indeed that the rollout of COVID vaccines have helped drive some of the positive economic news that we have seen over the last six months. The US Bureau of Labor Statistics reported a 0.3% decrease in unemployment, from 6.1% to 5.8%, in the month of May. As one might expect, the sectors that gained the most jobs were Leisure and Hospitality, Health Care and Social Assistance and Public & Private Education. Manufacturing has also performed well, reporting its highest growth level since August 2018.

The OECD projects that the US will grow by 6.9% in 2021, up from its March forecast of 6.5%. Given that economists had previously not expected the US economy to regain its losses from the Coronavirus outbreak until Q2 or Q3 of 2021 at the earliest, this is very encouraging.

The lesson here, perhaps, is to never underestimate the resilience of the US economy. For all of the talk about the US dollar losing its dominance, its status as the world reserve currency and its performance against the pound and the Euro thus far in 2021 suggests that it will continue to provide a safe haven for investors all around the world.

The Eurozone has shrunk so far in 2021, but it’s not all bad news

Whilst the first quarter of this year showed a small (0.3%) contraction in GDP across the Eurozone, the outlook for the remainder of this year provides grounds for cautious optimism.

The World Bank had originally forecast a 3.6% rate of growth in its January forecast; this was revised upwards to 4.2% in its most recent Global Economic Prospects Report, released in June. This comes following a year of eye-watering economic data from Europe: the Eurozone suffered a 6.8% drop in GDP in 2020, a record fall, and the European Union saw a 6.4% contraction.

This is broadly consistent with the pattern observed in the UK, which, as we have seen, contracted at the beginning of this year but has started to see the green shoots of recovery – and recover at a much faster pace than had been predicted. Whilst the projected rates of growth for 2021 are lower in the Eurozone due to a slower vaccine rollout, there are signs that the Eurozone is catching up.

Much of this country will be fuelled by the Bloc’s €800bn Coronavirus recovery fund. This received unanimous approval and received sign off from Ursula von der Leyen, the President of the European Commission, on June 16. Spain and Italy, the two countries hardest hit by the outbreak, will be the main beneficiaries of this fund, receiving close to €70bn. Ongoing policy interventions, such as the various furlough schemes, have also helped avoid an increase in the Eurozone unemployment rate.

Europe’s industrial performance appears to be showing the same signs of recovery that are to be seen in the USA: industrial production was up 10.9% in March compared to the same month in the previous year. Much of the positive industrial news is fuelled by Germany, where industrial output was 26.4% higher in April 2021 than it had been in April 2020.

It remains to be seen, of course, whether the more optimistic projections regarding the Eurozone’s performance will be vindicated. It seems likely, however, that the countries of Europe will move at different speeds. Germany and other northern countries will likely benefit from strong manufacturing growth driven by American and Chinese demand, whilst Portugal, Spain and other southern nations will likely endure a great deal of uncertainty with regard to the European tourism season and whether it will continue as normal over the summer months.

The Far East: China continues to pull out in front

Both the Chinese and the Japanese economies have performed well in 2021. This aligns with the broadly positive economic data that we have seen from the UK, USA and the Eurozone thus far in 2021.

China is currently looking at a growth forecast of 8.5% this year and 5.4% the following year. Much of this growth has been powered by the resurgence of Chinese exports. Compared to the first quarter of 2020, the value of Chinese exports increased by a massive 38.7% in the first quarter of this year.

Such growth is hardly surprising, given that China shuttered its factories and introduced lockdowns across large swathes of the country at the beginning of last year. These measures culminated in China’s GDP expanding by just 2.3%. Whilst this was its slowest rate of growth in over 40 years, the very fact that China even achieved growth is significant here: China was the only trillion-dollar economy to achieve a positive growth rate in 2020.

Whilst the overall picture is positive for China, the global recovery in demand has led to a rise in the costs of raw materials. This has caused financial pain for a number of Chinese companies, which may be forced to slow their ratces of production. With the producer price inflation now at its highest level in almost 13 years, it seems likely that the pain will be felt on a global level in the form of higher prices worldwide.

Japan saw a 1% contraction in GDP in the first quarter and is set to enjoy a 2.6% increase in output overall in 2021. In this regard, it is much like the UK and the Eurozone, which reported shrinkages in GDP at the beginning of this year but are widely expected to achieve positive growth by the end of this year. This contraction at the beginning of the year came after sanitary measures were reintroduced in early 2021.

With that said, COVID will act as a drag upon the economy for the foreseeable future: the economic benefits of the 2021 Tokyo Olympic Games, for example, will be rather limited this time round, as they are to be held without foreign spectators. Much like China, Japan is likely to see a slower rate of growth in 2022 of 2% according to the OECD.

Monetary policy: inflationary pressures continue to pose a challenge

In the wake of the Coronavirus outbreak, which led to major stimulus bills being passed in an attempt to encourage higher consumer spending, governments and central banks across the world – many of which used to be concerned that inflation rates were too low – are worried by recent increases in inflation.

Russia is an interesting case study of these inflationary pressures in action. Annual consumer inflation accelerated to 6% in May; this was its highest point since October 2016, and higher than the 5-5.5% increase that had been anticipated. In response, Russia’s central bank hiked its key interest rate to 5.5% on Friday, June 11, 2021, in an attempt to control the rate of inflation. In October 2021, Russian Finance Minister Anton Siluanov was quoted as saying that there would be an increase of around $420 million in social support payments to Russian households in 2022, in an effort to deal with higher than anticipated inflation.

The Eurozone saw a 2% increase in inflation in May, up from the 1.6% increase in April; May’s increase was above the target set by the European Central Bank and occurred due to a rebound in energy prices, which are now 13% higher throughout the Eurozone than they were a year ago.

Meanwhile, the USA has also seen its highest inflation rate since 2008; this can be attributed to several different factors, such as increasing demand, supply chain bottlenecks and the effects of lockdown. As a consequence, US consumer prices have increased at the highest rate in nearly 13 years in May, year-on-year.

FX markets

The recent performance of the US dollar has been very impressive, pouring cold water on the consensus view that it would be a weaker currency in 2021.

As we stated in our report at the end of 2020, it would be a mistake to write off the dollar: as the world reserve currency and a safe haven for currency investors around the world, the US dollar has remarkable staying power and is likely to perform well throughout the remainder of this year.

This view is supported by the most recent economic data (mid-June 2021), which has seen the pound slide against a strong dollar and the Euro drop below $1.20 for the first time since May 6, with EUR/USD expected to decline from 1.22 to 1.14 at the end of 2021.

The risks to FX markets

A new variant of COVID and another raft of lockdowns may well inflict another shock upon the global economy. It is likely, in those circumstances, that investors will seek the safety of the US dollar.

It also seems likely that the Euro will perform better throughout the remainder of this year as Europe’s COVID relief measures come into force and the vaccine rollout increases.

The year ahead in summary

The outlook remains very uncertain, but certain trends have emerged from a variety of different markets that give real reason for optimism: whilst the beginning of this year saw a decline in GDP – a hangover from the dark days of 2020 – we have begun to see the green shoots of recovery in the UK, the USA and the Far East.

A similar recovery is widely anticipated throughout the Eurozone too, as the effects of the EU’s anticipated COVID relief measures start to be felt and an increasing number of at-risk people receive their vaccinations.

The dollar is likely to act as a mainstay in these times of economic turbulence and uncertainty. If the economic data that we have seen in the first half of 2021 are anything to go by, much better times lie ahead in the latter half of 2021.


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