The near-term, tactical outlook for the US Dollar appears positive. An unchanged message from Fed Chair Powell in Thursday’s live Q&A, despite the recent Treasury market sell-off, may be viewed by the market as a passive endorsement of the price action. Indeed risk assets sold off with all major indices in the US closing in negative territory, with the negative sentiment spilling over into Asian and European openings.

As such, a continued move higher in US yields, and a potential consequent risk off across equity markets, could set the stage for further USD gains. USD gains may ultimately be constrained by the Fed’s sensitivity to US financial conditions since as Fed Chair Powell reiterated on 4 March, the central bank would be concerned by any disorderly market conditions. Indeed we expect the Fed to intervene via open market operations in order to keep the rising yields from differing materially from economic reality.

Given that the real economy is only at the initial sensitive period of recovery, we expect the Fed to ensure that rising yields which reflect rising inflation are at a sustainable level. This is especially due to the expected sharp, momentary increase in inflation due to the re-opening of economies, prior to normalisation.

We do also continue to think that stabilization of US yields at higher levels, will coincide with renewed USD gains in the immediate future, as demand for the currency increases on a relative basis, compared to other currencies. That said, given how loose conditions currently are, we may need to see further risky asset weakness and USD strength prior to USD bears being rescued from a more dovish Fed message.

Financial markets are entering a period of renewed volatility over the future actions of central banks, with the volatility indices spiking significantly over the past 2 weeks. On a technical basis this is also positive for the USD, which remains being viewed as the traditional safe haven asset.

Having said that, we do not expect the USD to move to pre-pandemic levels unless real yields move significantly higher, since as such they remain significantly negative, particularly on the front end of the curve.

Therefore, despite the positive tailwinds surrounding the bull case for the USD, which we expect to outperform G10 countries in 2021, we do not expect dramatic moves to pre-pandemic levels unless real yields rise significantly and more than other countries on a relative basis.

In this light, the growth of the US economy remains key, with both monetary and fiscal policies affecting the speed and magnitude of the recovery. The passing through of Biden’s aggressive spending programme is a key element to the story, with the positive news over the weekend expected to give the US economy more traction in its economic push towards recovery.

Indeed the medium term outlook is more mixed, as the hysteresis caused to the US economy as a result of the pandemic remains unknown since we are still technically in the midst of the pandemic, despite the easing of restrictions in some states last week, notably in Texas.