Dollar Weakness Resumes in April... Won-to-Dollar Rate Expected to Reach 1050 by Year-End

[Asia Economy Reporter Song Hwajeong] The dollar is weakening as the economic gap between the United States and regions outside the U.S. narrows.

According to Samsung Securities on the 24th, the dollar has shifted to weakness against major currencies since the beginning of this month. The dollar, which had been weak throughout the second half of last year, appreciated about 4.3% until the end of March following the realization of the Blue Wave (the U.S. Democratic Party controlling the White House and both houses of Congress) earlier this year. However, in April, the dollar resumed its weakness against major currencies, depreciating about 2.2% in just over 20 days. The KRW-USD exchange rate also appreciated about 2.4% from the intraday high of 1,145 KRW in mid-March.

Samsung Securities researcher Heo Jinwook explained, "The biggest reason for the recent shift to dollar weakness is that the economic gap between the U.S. and regions outside the U.S. began to narrow again starting at the end of March. In particular, unlike the U.S., the Eurozone, which showed sluggish economic performance throughout the first quarter, saw its economic outlook rapidly improve in April, leading to a 2.7% appreciation of the euro against the dollar, driving the dollar's weakness."

Samsung Securities cited three factors for the resumption of dollar weakness: ▲ slowdown in U.S. fiscal expansion momentum ▲ acceleration of vaccine rollout in the Eurozone ▲ narrowing short-term interest rate gap between the U.S. and Germany.

First, the momentum for U.S. fiscal expansion slowed as a series of large-scale fiscal policies culminated with the $1.9 trillion fifth stimulus package agreed upon in mid-March. The subsequent $2.3 trillion infrastructure investment plan is a total amount spread over the next 10 years and includes tax increases, so the annual net spending is expected to be less than 1% of GDP. Researcher Heo said, "The U.S. economic growth rate is expected to peak at 10-12% (annualized) on a monthly basis in April-May and then gradually slow to an average of 5-7% in the second half of the year. In other words, most of the positive factors have already been priced in for the U.S." In contrast, the Eurozone's symbolic fiscal expansion policy, the Recovery Fund, is expected to be approved in June and start in early July. Heo explained, "The launch of the Recovery Fund, along with accelerated vaccine rollout, will maintain the Eurozone's economic growth rate at an average of 8-10% through the third and fourth quarters of this year. Unlike the U.S., the Eurozone's positive factors are just beginning, and the euro's strength will lead the dollar's weakness."

The pace of vaccine rollout in the Eurozone is accelerating. Until March, the Eurozone's daily vaccination rate was significantly slower than the U.S. due to supply disruptions, but since April, it has been progressing more than 50% faster. Heo said, "As of the end of March, the vaccination rate in four Eurozone countries (Germany, France, Italy, Spain) was only 12% of the total population, but it is expected to accelerate rapidly to 30% in May and 50% by the end of June. The acceleration of vaccine rollout raises expectations for economic improvement in the Eurozone, leading to a narrowing of the Purchasing Managers' Index (PMI) gap between the U.S. and the Eurozone."

The interest rate gap between the U.S. and Europe is also narrowing. Generally, exchange rates respond much more sensitively to short-term interest rate differentials than to long-term rates. Heo said, "The interest rate gap between the U.S. and Germany on 2-year government bonds explains short-term fluctuations in the USD/EUR exchange rate well. The euro, which weakened due to the widening U.S.-Germany short-term interest rate gap in February and March, turned stronger against the dollar in April as the interest rate gap between the two regions rapidly narrowed." He added that with accelerated vaccine rollout and the start of the Recovery Fund, the Eurozone's growth rate will accelerate, continuously narrowing the U.S.-Germany short-term interest rate gap and supporting the euro's value.

As the economic gap between the U.S. and the Eurozone continues to narrow through the second quarter and into the second half of the year, a gradual strengthening of the euro against the dollar is expected. Heo said, "Regarding the Chinese yuan, considering the expansion of the current account surplus due to strong exports and the yuan's value stability under the dual circulation strategy, a moderate appreciation trend of the yuan is expected to be maintained in the medium to long term. Accordingly, we maintain our year-end forecasts for the USD/EUR and USD/CNY exchange rates at $1.25 and 6.20 yuan, respectively."

Samsung Securities maintained its year-end forecast for the KRW-USD exchange rate at 1,050 KRW. Heo explained, "According to the Real Effective Exchange Rate (REER) model, which shows the valuation of the won, the current KRW-USD exchange rate is close to the long-term equilibrium level (about 1,140 KRW). The won, which is highly sensitive to exports, has entered an overvalued phase exceeding the long-term equilibrium level during the global synchronized economic expansion phase. Under a gradually weakening dollar environment, the KRW-USD exchange rate is expected to be around the 1,050 KRW level by the end of this year."