FX Outlook 2023: Major Currencies Forecast

FX Outlook 2023: Major Currencies Forecast

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Following a year of slowing global economy on aggressive fiscal and monetary tightening, reimposed Covid restrictions in China and the Russia-Ukraine war, weaking growth is expected to linger into 2023. Here are some insights on FX outlook 2023 that will help shaping your perspective with insights about the global economy and the anticipated performance of major currencies.

The Global Economy – Overview

We can call 2022 the year of the US Dollar which skyrocketed full of steam throughout the year. Last year, we indicated that “the USD is set for more gains in 2022, thanks to the Fed’s tightening bias and solid economic performance.

While it would be another disappointing year for the EUR/USD as policy divergence between Fed and ECB will likely remain the main driver for more losses.”. Fed’s tightening moves along with arising geopolitical tensions and soaring inflation pushed investors towards the safe haven greenback.

The Euro fell below the parity level as worries built over an inventible recession and amid rising concerns on the ECB’s credibility in taming the hot inflation and stimulating the slowing economy.

Meanwhile, the British Pound plunged on the political instability seen in the UK.

Elevated inflation and rising interest rates have been the major themes for the last year, as disposable incomes and purchasing power shrunk in most economies on the backdrop of tighter monetary policy and the central banks’ marathon to lift interest rates at the quickest pace in three decades to sooth inflation from its multi-decade high.

Read more on FX Market Trends in 2022

Higher rates caused an acute slowdown that is expected to continue this and the outlook still uncertain on how resilient the global economy would be against the recession threat.

Among the major themes that will define FX outlook 2023 is the fight of global economies against inflation and additional monetary tightening coming along the way. Central banks are widely expected to trade off high inflation for higher unemployment and slower growth.

How the global economy is going to perform under higher rates is also a main theme that worth watching along with stubborn inflation. However, central banks may have to gradually shift towards a neutral stance later this year to mitigate recession risks.

The global economic growth is set to be expand at a sluggish pace this year given tightening financial conditions.

In its latest world economic outlook, the International Monetary Fund expects the global growth to slow to 2.7% in 2023, the weakest growth since 2001, excluding the global financial crisis and the COVID-19 pandemic acute phase. According to the outlook published in October last year, IMF expects the global inflation to cool down to 6.5% in 2023 and to 4.1% by 2024.

FX Outlook 2023

USD – Bullish as Inflation Fight Continues

Despite the tougher outlook awaiting the global economy and the challenges facing the US economy, the US Dollar is likely to remain at historic highs during the first half of the year. However, the greenback may weaken over the course of the second half of 2023 as the Fed slows down it’s tightening cycle.

Interest rates in the US are widely expected to peak around 5% in Q1 2023. But given the recent speeches from several FOMC members supporting more rates hikes, the bank may keep hiking during the first half of 2023, even at a slower pace.

Cleveland Fed President Loretta Mester and St. Louis Fed President James Bullard have expressed their shared views on rising interest rates above 5% as quickly as possible.

According to Goldman Sachs, the probability range for the recession risk in the US in 2023 is 45–55% and adjustable to upcoming data. The key arguments of recession include rising interest rates across the Treasury yield curve, incremental cost of borrowing for households and businesses and the decline of stock markets.

On the other hand, experts predict that the US economy will narrowly avoid a recession. However, if inflation remains too high, despite the aggressive hiking cycle began last March, the bank might run out of options other than trading off high inflation with sluggish growth.

As inflation continued to run-higher, the committee started to raise interest rates at each meeting since June by 75 bps until December when the bank scaled down rate hikes to 50 bps.

If the US economy slipped into a recession with inflation above 5%, the Fed will be in a challenging position given the little latitude in bringing inflation to target ranger while keeping stimulating the economy.

Until that, the outlook for the US Dollar remains bullish for the first half of 2023 and is set to outperform against major rivals including the Euro and the Japanese Yen. The greenback’s resilience will largely depend on Fed’ policy pivot regarding inflation.

FX Outlook 2023,USD From The Editor
DXY Chart – Source: Tradingview

But given that the Fed is approaching the end of the policy tightening cycle, the USD may not see new higher peaks as global currencies may be able to regain some resilience against the buck.

Euro – Bearish Bias amid Uncertain Outlook

Unlike the US economy, the European economy is probably in recession. The Block’s economy is facing tougher challenges being more vulnerable to the fallout of Russia-Ukraine war, struggling with higher inflation and relatively weaker growth.

High inflation in Europe is mainly supply driven. Against the hawkish outlook for ECB policy, the bank might shift its guidance on interest rates once prices start cooling down across the block. That could sustain interest differentials curbing Euro’s gains against the USD.

The Euro had a tough year in 2022, as the Russian war with Ukraine along with weak growth flared. The ECB was very cautious in hiking interest rates to tame inflation in order not to curb the growth. But eventually had to accelerate its hiking cycle which helped the single currency to cut some of its losses by the end of the year.

FX Outlook 2023,USD From The Editor
RUR/USD Chart – Source: CNBC

However, ECB’s cycle has just begun and as inflation remains elevated and growth still weak, the bank is may have to raise interest rates in a recessionary backdrop.

The ECB is likely to pursue rate hiking in H1 2023 to peak near 3%. Risks on rate’s path may stem from persistent core inflation or a deeper recession.

So, the debate here is how long the ECB will be able to maintain its hawkish stance without slowing the economy?

Keeping the ECB’s policy and sluggish growth in mind, the outlook remains bearish for the EUR mainly against the USD, JPY and GBP going into March 2023 at least.

GBP – Dim Outlook Burdens Short-term Recovery

After having one of its bad years, the scenario for the British Pound will probably remain the same in 2023. GBP plunged broadly against the USD, the EUR, the Swiss franc and commodity currencies.

The British Pound tanked and nearly approached parity against the US dollar burdened by the political chaos of switching three prime ministers, four finance ministers, not to mention the turmoil of UK budget.

The UK economy is set to underperform during the year as long as the energy crisis persists, dampening growth and pushing inflation higher.

In this regard, the overall outlook for the UK and GBP remains pessimistic.

FX Outlook 2023,USD From The Editor
GBP/USD Chart – Source: CNBC

With stagnated economic activity, the pound may not be able to escape the bearish trend anytime soon. However, experts believe that the pound may strengthen in case the labor market recovers. Upside risks also include any material fall in energy prices that may slash pressures on prices.

JPY – Will Safe Haven Flows Offer Support? 

The Japanese yen was hardly hit in 2022 by US higher interest rates and stronger dollar. The inflation in Japan climbed to over 3%, and the Bank of Japan intervened to support the currency.

The widening gap of monetary policy between the Fed and the Bank of Japan outweighed the safe haven inflows for JPY. The USD/JPY rose by over 15% pushing the yen to its lowest in decades against the US dollar.

FX Outlook 2023,USD From The Editor
USD/JPY Chart – Source: CNBC

But the outlook looks promising for the Japanese currency which is anticipated to firm against major currencies.

The Japanese Yen is expected to gain some steam this year as the Fed is approaching the end of its rate hiking cycle, giving more space for safe haven currencies like the yen to recover.

This year, the main question is whether the BoJ is ready to join its global counterparties in policy tightening. That’s not expected at least until April 2023, when BoJ Governor Kuroda’s term comes to an end. The focus will be whether the next governor be little less dovish, or will follow Kuroda’s extremely dovish stance.

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