Currency Outlook First Quarter 2023
The last quarter of 2022 saw the major bull trend of the U.S. dollar reverse after 18 months. While the dollar may experience some short-term weakness, conditions are still unclear on whether the dollar will have a new bull trend in 2023. The Federal Reserve looks to continue hikes into 2023 but markets are not sure for how long. The war in Ukraine is in its 10th month and while Ukraine has reclaimed territories, the drone bombing campaign by the Russians has increased.
Some of the dollar weakness has been attributed to these successes in Ukraine, but that can quickly reverse if conditions worsen. Fragility in the Eurozone currencies should continue during the winter months as energy continues to weigh on those currencies. Recession fears have had its effect on the bond market, which could see a continued rally into 2023 and impacting flight to safety currencies like the Yen and the Swiss Franc. Recessions for foreign exchange don’t necessarily mean trends, but almost always mean more volatility, which is a possibility next year.
The bear trend for EUR/USD ended in October and the end of year markets have exaggerated the move higher with prices topping above 1.07. As we head into the new year, the conditions in the energy sector should continue to worsen and keep downward pressure on the Euro. Energy and food prices continue to rise and are impacting inflation in Europe even more than here in the U.S. Safe-haven status for the U.S. dollar should continue as we should experience increased periods of volatility.
Euro has gained 10% in the fourth quarter after being down 18% since January, but this move is most likely near the end. The ECB seems to be committed to keeping rates higher to fight inflation. The Fed is also committed, and in addition Fed Chairman Jerome Powell will take steps toward reducing its balance sheet.
Like the EUR/USD move, GBP/USD fell 25% before recovering 11% in the fourth quarter. GBP collapse in September due to failures in policy by the U.K. government that resulted in the market losing faith in the U.K. Gilts and their currency. As we head into winter, the British economy will continue to be impacted by the Russian invasion of Ukraine and impact on energy prices. The cost-of-living crisis will continue to impact British citizens into 2023.
The U.S. dollar has sold off recently as bond yields continued to drop. I would expect these impacts will dissipate into 2023 and would expect more volatility as recession becomes reality. As markets pull out of risk assets across the globe, we should expect periods of flight to safety in U.S. dollars and other defensive currencies like Yen and Swiss.
AUD has bounced 11% despite the impacts their economy and exports had from China covid shutdowns. Australia’s inflation and interest rates are running cooler that the U.S. The Aussie government is looking for a removal of export tariffs next year, which should prove more favorable for the economy. Growth is expected to slow but remain above global expectations at 3-4%. As China reopens and the Fed pivots as recession becomes more likely, we could see a continuation higher with more volatile markets.
The Bank of Japan had been steadfast in keeping policy unchanged while the rest of the world has been hiking rates. That was until they surprised the market by “modifying the conduct of the yield curve control in order to improve functioning.” The result was a sharp selloff in US dollars of 4% overnight. The Bank of Japan will be increasing the amount of JGB purchase (bonds), which may be the first step towards tightening and ending a decade long policy of easy money. Governor Haruhiko Kuroda’s term ends in April 2023, and this latest move could trigger higher bond yields and losses in Japanese Government bonds and Japan equities.
There also could be global implications on U.S. assets selling off in favor of Yen. The strong dollar move goes back to January 2021 when the U.S. 10-year treasury yield crossed 1%. The dollar finally saw relief due to Bank of Japan intervention above 150 Yen. The recent continuation of Yen strength is pricing in a U.S. recession, before the BoJ announced they would buy their own bonds. I wouldn’t be surprised another 4-5% move lower before prices stabilize.
Written by David Grimaldi, TM Foreign Exchange Sales Consultant
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