More weakness before eventual bounce

The US dollar index (DXY) is headed for the first annual decline in two years as the risk-on sentiment remains. The currency has dropped by more than 8% this year and by more than 12% from its year-to-date high of $103.

US dollar dropped against most currencies

The US dollar fell against most currencies in 2020. It fell by 8.3% against the euro, 3.3% against sterling, and 4.8% against the Japanese yen. The currency also declined against emerging market currencies like the Hong Kong dollar, South African rand, and the Singapore dollar, among others.

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This decline is mostly because of several factors. First, in response to the coronavirus pandemic, the Fed decided to unlock liquidity in the United States. It slashed interest rates to between 0.0% and 0.25%.

It also printed trillions of dollars through its quantitative easing program that pushed its balance sheet to more than $7.7 trillion. Further, the bank unveiled other measures to provide financing to small and large businesses.

Second, the dollar index also dropped in response to the additional funds provided by Congress. In total, Congress allocated more than $3.9 trillion in stimulus in 2020. And there is talk about another stimulus in the coming year. These funds have gone directly to states, individuals, and companies.

Finally, the index declined as the level of global risks eased. For one, companies were successful in developing a coronavirus vaccine. Also, the election of Joe Biden reduced trade and geopolitical risks in the near term.

US dollar outlook for 2021

In 2021, the dollar index will be in the spotlight because of how badly it performed in 2020. Some analysts believe that the currency will continue to struggle in the coming year. For example, those at Goldman Sachs see it dropping by 15% until 2023. In a statement, Zach Pandl, an analyst at the bank said:

“We are currently forecasting about a 15% depreciation in the real trade-weighted dollar from this year’s peak to the end of 2023, but a larger move is certainly possible.”

However, there are several catalysts that could push the US dollar higher in 2021. First, investors could start worrying about global debt, which has risen by more than $20 trillion this year. This will be a positive aspect for the greenback, which is often seen as a safe and stable currency.

Second, the dollar could gain if there is a strong rebound of the American economy, pushing the Fed to turn hawkish.

Finally, like during the Obama era, geopolitical risks could remain, which will be a positive thing for the currency.

Dollar index technical outlook

On the weekly chart, we see that the DXY has been in a steady downward trend. It has managed to move below the 78.6% Fibonacci retracement level. It is also below the short-, medium-, and longer-term moving averages. The Relative Strength Index (RSI) has also crossed the oversold level.

Therefore, in the near term, forex investors will possibly push the index lower to the February 2018 low of 88.26. At this point, it will be extremely oversold, which will possibly push it higher. Explore our free forex trading courses for more information about technical analysis.