In some professions it is not sufficient to be partly right. Bomb disposal, for example, springs to mind in this context. But, to an extent, so too does currency forecasting. Back in April 2020, amid the grip of the first wave of COVID-19, we took a scenario-based approach to the outlook amid the acute uncertainty. We identified four possible economic paths1 – “L”, “U”, “V” and “!” and subsequently pinned our forecasts on the assumption of a “U-shaped” outcome for the global economy and the FX market2. It set us on a path of forecasts that have been mixed in  terms of accuracy. 

The U-shaped scenario was suggestive of uncertainty over the growth upswing. Under such circumstances, those countries with the greater policy room for manoeuvre to support growth were expected to see the strongest currencies. It also pointed to a divergent USD, weakening against the AUD, NZD, NOK and SEK in G10 but strengthening against the EUR, GBP and CAD. We also liked a number of EM currencies versus the USD, including most of Asian FX, the MXN and RUB. Part of this stance has worked well. Since the start of April, the NOK, NZD, SEK and AUD have been the best performing currencies in G10. However, our expectations for the USD to stage modest gains versus the EUR, GBP and CAD have not worked (Chart 1).

‘V’ rather than ‘U’

The price action has been more consistent with the “V-shaped” scenario we outlined in April rather than the “U-shaped” scenario which drove our forecasts. In the “V” scenario, we argued that RORO would remain dominant. AUD, NZD, NOK and CAD would outperform given they had been most adversely affected during “risk off” period. They were also best placed to capitalise on commodity price gains alongside the economic upswing. The safe-haven USD, JPY and CHF would be the laggards. In contrast to the “U” scenario, the USD would not be in the middle ground – it would be bottom of the league. It seems this is how it is playing out. Massive monetary and fiscal easing have allowed markets to retain their “V-shaped” mindset despite renewed waves of COVID-19 in many countries (Charts 2 and 3). Expectations for disbursement of a vaccine through 2021 have allowed risk appetite to shrug off the current wave of renewed containment measures. A selectively risk-positive spin on the implications of the US election outcome has also sustained the reflationary theme for 2021.