The party in equity trading continues in New Year with the global stocks hitting fresh highs and local equity indices also doing the same. While all risky assets soared in the last year, the concomitant risk appetite pulled the US dollar sharply lower. Hopes for a sustained economic recovery and continued Covid-19 vaccinations in a number of countries are keeping sentiments supported, according to a lot of investment advisory services.  While the financial assets also extended their recent trends in the year 2021, the US dollar also stayed on an edge, testing around two and half year low as measured by the dollar index. The Dollar index slipped 7% in 2020, marking its first slide in four years. It is clear that the drop in US dollar has played a key role in keeping demand for risky assets like stock markets elevated. Needless to say that the trend in US dollar will turn out to be a defining factor for world stock markets. 

Here are five key points that will shape up the narrative for US dollar in the current year and its impact on the equity markets.

The Biden Administration:  After a hurried turmoil in US Capital in first week of January, the US is set to see a transition into new presidency. The United States Congress has certified Joe Biden’s election as the 46th President of the US after counting of Electoral College votes. The US economy will likely continue to recover on Biden’s plans to spend $2 trillion on building infrastructure. With the election, the US Democrats have taken control of both houses of Congress and the White House, ensuring that plans to increase government spending to prop up the economy will likely see a smooth passage. 

US Treasury Yields: US benchmark 10 year treasury yields have been soaring in recent weeks after witnessing a sharp slide in the aftermath of the Covid-19 crisis last year. The yields shot up above 1.10% to hit a one year high. The US dollar has been sliding over last few months as yields held up near record low and the latest spurt has also triggered some strength in the US dollar. However, yields are unlikely to move up much as US Fed Chief Jerome Powell has recently noted that the Fed would increase its balance sheet expansion if the recovery slows. 

US Federal Reserve: The monetary policy of the US Federal Reserve will also play a greater role in shaping up the movement of the US dollar. The US federal funds rate is currently in a range of 0% to 0.25%. The Fed first lowered the rate to almost 0% on March 15, 2020. The near term interest rate outlook as the US interest rates outlook is still very dovish. The Fed also continues its asset purchase program at least at the current pace of 120 billion US dollars per month and has noted that it will do it until it sees substantial further progress in employment and inflation.

Covid-19 Scenario: While the wide spread Covid-19 vaccination drives in a number of countries are set to keep a tab on the pandemic in near term, a resurgence in fresh cases could weigh on the world economy in coming months. The US dollar could be in demand as it was around a year back.  

Economic Growth In Other Regions: The US Dollar Index is a prominent benchmark to measure the value of the dollar against a basket of six world currencies. The index drives its value based on the underlying trends in the other currencies and economic trends in other countries also weigh on the dollar. Therefore, if Eurozone economy is not strong enough in comparison to the US, it will likely weaken the Euro against the US dollar and will lead to rise in the broader Dollar index too. Indeed, this scenario seems to have been playing out in first two weeks of January 2021 when the US dollar index marked a modest rise from its recent low. The current lockdowns in Europe are keeping the dollar supported it seems. 

Conclusion

Equity trading has witnessed a highly exuberant activity over last one year and most stock brokers in India are expecting local markets to extend their awesome gains over the coming months. For the global markets, it will all boil down to the recovery post Covid-19 pandemic and the movement of the US dollar index. Weakness in US dollar has been supportive for stocks in recent times. If the dollar index does not see an abrupt spurt, the equity market activity should largely stay supported. Also, the US Fed is unlikely to resort to a hike in interest rates soon given its favoured measure of inflation – the core personal consumption expenditure stays at 1.4% compared to 1.70% about a year ago and nonfarm payroll employment is nearly 10 million below its pre-pandemic level.