FX Talking: FAIT Seals The Dollar Bear Trend

The Fed’s shift to Flexible Average Inflation Targeting (FAIT) has been – and will continue to be – a significant bearish factor for the dollar. This reflationary policy embeds an assumption that a weaker dollar will play a role in stimulating US growth and allow the Fed to reach its goal of full and inclusive employment.

 See the full report FX Talking: FAIT seals the dollar bear.

Executive summary

The question is whether this is just the latest round in the global currency war and major trading partners (e.g., Europe) will quickly act to neutralize their domestic currency strength by adopting similar policies? What may be more important, however, is that a weaker dollar will export looser monetary policy around the world – a positive move for cyclical currencies including the EUR, commodity and EM currencies in general.

Febrile conditions ahead of US November Presidential elections may well keep risk assets in check – hence our 1.20 EUR/USD forecast for year-end. But we now feel comfortable with most scenarios dragging EUR/$ to 1.25+ through 2021. This should be good for most European currencies, out of which we’d pick the CZK as a top performer. Events in Russia will certainly have to be monitored, however.

In theory, reflationary policy should be good for the equity-driven Asian currencies. We now look for USD/CNY to head to 6.70 into next year and expect the KRW to play catch-up to 1140 as 2021 progresses. EM policies which sail close to the wind, such as those on Indonesia, may take a further toll on local FX. And in Latam, we still prefer BRL over MXN, despite some doubts emerging about the strength of Brazil’s fiscal responsibility.

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