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Goldman Sachs: U.S. Dollar Depreciation Ahead, Second Covid Spike Fears Overdone

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A key market theme at present is the question of whether or not a second spike in covid-19 infections is brewing, particularly in the U.S. where a number of states have are seeing infection rates rise markedly.

The concern has understandably introduced some volatility into equity markets and contributed to a return to strength in the U.S. Dollar, which serves as the world's reserve currency and is therefore a natural beneficiary when equity markets are selling off.

In fact, so important is the pull and push of equity markets that many analysts and foreign exchange commentators suggest the FX market is currently an equity market play. Therefore, the outlook for foreign exchange in general and the Dollar in particular, could rest with whether or not a second spike in covid-19 infections is looming.

But economists at Wall Street bank Goldman Sachs say that this is unlikely, and as such they do not expect the Dollar to remain supported.

"At the moment we do not see major risks of a second wave in the US or other large economies, and our economists forecast a relatively steep rebound in activity over the next few months—indeed, they revised up their near-term forecasts last week," says Zach Pandl, a senior economist at Goldman Sachs.

"This should allow for a continued pro-cyclical rotation across assets and renewed Dollar depreciation," adds the analyst.

The nationwide infection rate in the U.S. has risen again to 7.9 per 100K while in Brazil 14.8 cases per 100K inhabitants have been announced.

"The FX markets are caught between two conflicting drivers at present. On the less supportive side is the growing evidence of a second wave of Covid-19 infections in the US. The headwinds for the risk rally have been further compounded recently by simmering geopolitical tensions between North and South Korea as well as India and China," says Valentin Marinov, Head of G10 FX Strategy at Crédit Agricole.

Infections Covid

"Recent developments are a good reminder that “bad news” from the US can paradoxically lift the Dollar if it affects investor risk appetite or raises questions about the global economic outlook," adds the analyst," says Pandl. "Investors more concerned about worsening US and/or global growth should consider skewing USD shorts toward up-in-quality crosses like JPY and CHF."

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