Even before the pandemic, the US was one of the few economies generating inflation. If they continue to do so after the pandemic, without a policy response from the Fed, periods of accelerating inflation will reduce the purchasing power of the dollar, which is then likely to weaken progressively.
The Fed (its last monetary policy meeting for 2020 is expected tonight) has other arrows in its bow that it can use to further ease financial conditions, including explicitly controlling the yield curve. This strategy, currently followed by the Bank of Japan, would bring bond yields within narrow ranges along the yield curve, preventing them from rising due to rising inflation expectations, and in doing so the dollar would weaken further.
In the absence of a political agreement on fiscal stimulus, the Fed could also activate its private credit lines, which would result in a guarantee programme for consumers and small businesses, like the one adopted in the UK. This would cause a further expansion of its balance sheet and thus a depreciation of the greenback.
One of the main causes of the dollar’s weakness next year will be the rapid deterioration of the US current account balance. The deficit is close to 3% of GDP, and is likely to widen rapidly in 2021.
As the US budget deficit is set to remain very high, close to the current 13% of GDP, a further economic recovery is likely to cause the current account deficit to widen sharply.
As the dollar is fully valued by most standards, it could easily depreciate substantially over the next 12 months.