The US Dollar has been loosing ground vs major counterparts over the past week. The market view has pushed back fears on monetary tightening from the Federal Reserve, which has provided a path for a weaker USD. Citi Analysts believe that the shift in tone is likely to come in the second half of 2021 capping the Dollar weakness.

Great British Pound (GBP)

Sterling has pushed to near year-to-date highs; as the UK’s vaccine rollout, economy reopening and economic data lifts sentiment. We have held a strong conviction on GBP upside going back to September 2020. In March as fears of Fed taper to combat inflation rippled through markets, our analysts moved to a more neutral stance. However the subsequent view of ultra-accommodative monetary & fiscal policy has been extended, with our outlook of some further near-term USD weakness.

As economic data continues to print with strong momentum, the question around inflationary pressures in the UK has gained attention. Current money markets pricing for a hike from the Bank of England (BoE) interest rate is September 2022 (+15bps). This is in line with the Federal Reserve at current, however Citi Analysts expect this pricing to shift later this year, with Fed pricing being ahead of the BoE. The comparative re-pricing is expected to lead to some USD appreciation, that ties in to our 6-12 month view.

The pathway for the economic reopening has been supported by improved consumer sentiment and demand after prolonged periods of economic/social restrictions. The leading vaccine rollout has underpinned the recent GBP appreciation.

US Dollar (USD)

A recipe for a tactically weaker USD remains despite a slightly more hawkish FOMC minutes.
The US economy has transitioned from a combination of real growth/ subdued inflation (higher real yields/ subdued break evens) in Q1’2021 to now more subdued real activity running up against supply constraints & higher inflation (falling real yields/ higher break evens) with a side-lined Fed.

This latter combination is US Dollar Index negative until either one of 2 things happen; the inflation proves transitory and/or supply constrains real economic activity. Or real economic growth passes through with inflation and the Fed signals the need to taper policy, which our analysts expect view as USD positive.

Euro (EUR)

An improved vaccine rollout trajectory, and a path out of economic lockdown is likely to see inflationary pressures as with the UK & US. The Eurozone has held deposit rates in the negative bound, adding to the potential for the economy to rebound. The key dynamic is will the inflation be transitory or prolonged. If it is the latter, this could provide the caveat for a movement in sovereign EUR yields, however the pace and relative momentum vs the US and UK could provide the headwinds for further Euro appreciation.

Citi Analysts FX Forecasts

Source: CIRA May 2021 Forecasts