At a glance
The US dollar appreciated substantially through the COVID-19 crisis as investors sought its liquidity and safe-haven appeal. But the Federal Reserve has been proactive in easing its policy stance and supplying markets with an unprecedented amount of cash, so yields have collapsed. We also see safe-haven demand for the dollar ebbing, assuming economic growth rebounds and a second wave of infections does not lead to further lockdowns. We expect the major beneficiaries of a broad-based fall in the dollar to be sterling, the Swiss franc, and gold.
Where next for the US dollar?
The US dollar index gained about 8% in the early stages of the COVID-19 crisis, pushed higher by safe-haven flows and an initial shortage of liquidity. But as the outlook for the pandemic has improved, the US currency has fallen, a trend we anticipate will continue for three main reasons. First, we see safe-haven demand for the US currency declining, assuming economic growth rebounds and a second wave of infections does not lead to further lockdowns. Second, the interest rate advantage that supported the US dollar in recent years has been eroded by the fact that the Federal Reserve has been more aggressive than other major central banks in monetary easing. Third, the US currency could be impacted by political uncertainty ahead of the presidential election in November.
We expect broad-based USD weakness and see three key beneficiaries of a weaker greenback:
Sterling is undervalued: The UK's currency has been weakened by uncertainty over trade talks with the EU and, more recently, the specter of negative rates. In our view, both of these offer more noise than substance and the risks to sterling should fade, which should prompt interest to return to—and, crucially, investment to rise in—the UK. The UK government and the Bank of England are maintaining their tightly coordinated approach in supporting the economy, which bolsters our conviction that sterling is set for a rebound. We also regard the British pound as heavily undervalued versus the USD with a purchasing power parity of 1.54. As a result, sterling is our preferred currency against the USD.
Swiss franc: The Swiss franc looks more stable than the USD as markets start to focus on stronger export activity. When growth returns and if rates remain close to the zero lower bound, the USD is likely to underperform. Fed Chair Jerome Powell recently said the Fed was "not even thinking about thinking about raising rates." The Swiss National Bank (SNB) has also come under criticism from the US for interventions to curb the appreciation of the franc, which may cause it to scale back future interventions. We expect USDCHF to move from a 0.95–1.00 range to a 0.90–0.95 range in the second half of this year.
Gold: Along with being a commodity, gold also functions as a currency. Since gold is denominated in dollars, the precious metal tends to appreciate when the US currency weakens. As a non-yield-bearing asset, gold also benefits from low or negative real interest rates that reduce the opportunity cost of holding the asset. We expect gold to reach USD 1,800/oz by the end of 2020.
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- The US dollar initially rallied during the COVID-19 pandemic, but has since started to weaken.
- We expect the currency to be undermined by an ebbing of safe-haven flows, a reduction in the US rate advantage, and political uncertainty ahead of the November presidential election.
- We expect broad-based depreciation of the USD, but we see particular upside potential for sterling, the Swiss franc, and gold.
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