Global economic conditions and monetary policy stances will heavily influence the outlook for foreign exchange markets in 2023. Economists should expect what?
Many countries are experiencing a reduction in war-induced inflation due to Covid-19. The global economy may be more resilient than previously thought, despite the need for further tightening monetary policy in key economies. Interest rate hikes may not cause a hard landing (or deep recession) as once believed. High energy prices, sluggish labor markets, and rising interest rates may take time to manifest their consequences.
Macroeconomic policies, geopolitical events, and uncertain macroeconomic policies impact foreign exchange markets. First, panelists suggested that the Federal Reserve may reduce its rate increases due to an apparent slowdown in inflation. As a result of tightening monetary policy, the economy was expected to suffer. The panelists said it is unlikely that the Fed will lower interest rates in 2023.
During the discussion, it was highlighted that it is difficult to decipher global macroeconomic conditions. In 2022, the German economy was predicted to contract sharply this year, but by late 2023, it will expand. Several potentially damaging macroeconomic hazards could trigger a latent downturn. Not only are energy costs rising, but household debt is also increasing. Rising interest rates create recessionary pressure as companies and families burn through their savings.
Since the Fed is nearing its terminal rate and slowing down its pace of hikes, the dollar has come off its highs and has room for further easing. In addition, they expect the euro to appreciate against the dollar by the end of 2023, largely due to improved macroeconomic conditions in Europe. The European Central Bank is considered more hawkish than the Federal Reserve, which would also support the euro against the dollar. As a result of more favorable rate differentials, one panelist predicted the yen would appreciate to 120/$. According to them, the strength of the yen and the tightening of monetary policy will be determined by domestic inflation.
In regards to the sterling, there was more uncertainty. One panelist put a positive spin on it and commented that a resurgence would ultimately depend on the ability of the UK economy to overcome self-inflicted wounds, including its departure from the European Union, a poor pandemic response, and a decline in international credibility brought about by Tory leadership struggles. Achieving such a feat is clearly difficult. According to the International Monetary Fund, the UK will be the only western economy to enter recession this year.
Are these elements indicative of the dollar’s role in the global monetary and financial system in the long run? Overall, the panel predicted that dollar dominance would continue. Alternative assets, such as the Australian and Canadian dollars, might be allocated by central banks, but these allocations remain largely marginal.
China’s attempts to improve the global standing of the renminbi will continue, but will be hampered by geopolitical concerns and China’s economic difficulties. There appears to be an increase in gold allocation in many emerging markets, which have lower liquidity than US treasuries (bonds generally) but offer emerging markets and China some modest diversification and protection against Western sanctions.
Thus, the panel’s forecast for foreign exchange in 2023 is as follows: the dollar will remain dominant but will weaken a bit from its late-2022 highs, the euro will strengthen, the yen may strengthen, and emerging markets will explore alternative currencies and commodities.
Looking for more opportunities to explore the alternative investment space? We can help. Register with us and our industry experts will get in touch with you to help you meet your investment goals. All you have to do is visit us and register.