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Currency Volatility: Will a Strong US Dollar Return?

Will we see the return of a strong dollar in 2023, and what’s in store for currency markets around the world?

February 3, 2023

2022 was a historic year. The U.S. dollar strengthened against nearly every other major currency to levels not seen in decades, as the Federal Reserve (Fed) aggressively hiked interest rates in a bid to combat inflation. On the whole, the nominal broad dollar index — which is used to measure the value of the dollar against a basket of currencies widely used in international trade — appreciated over 12% in 2022.

However, the greenback has trended weaker since, sending ripples through currency markets around the world. Against this backdrop of heightened forex volatility, what’s the outlook for the U.S. dollar, British pound, euro and Japanese yen in 2023?

The 2023 Outlook for Major Currency Pairs

Source: J.P. Morgan

GBP/USD is forecast to reach 1.20 in March 2023, before falling to 1.18 in June 2023, to 1.16 in September 2023 and to 1.15 in December 2023. EUR/USD is predicted to reach 1.10 in March 2023, before declining to 1.08 September 2023 and holding at 1.08 in December 2023. USD/JPY is expected to hit 135 in March 2023, before trading at 133 in June 2023, 130 in September 2023 and 128 in December 2023.

The Outlook for the US Dollar

After a historic bull run last year, the nominal broad dollar index fell almost 7% between November 2022 and January 2023. Such weakness reflects a mean reversion from the dollar’s outsized gains in 2022.

“The confluence of factors that had proved so supportive of the dollar earlier in 2022 has since inverted. Markets are now aggressively pricing Fed easing on the back of growing signs of disinflation, while the outlook for global growth this year is no longer looking as pessimistic as it did earlier in 2022,” said Meera Chandan, Global FX Strategist at J.P. Morgan.

Overall, while J.P. Morgan Research still forecasts modest dollar strength in 2023, it is taking a neutral stance on the USD. “We still hold longer-term reservations about the broader trajectory of the global cycle, which we think should be generally dollar-positive, but the interim period of both positive global surprises and less U.S. exceptionalism seems to point toward a period at the trough of the dollar smile, whose duration is uncertain,” said Chandan. “In our view, the top trading themes for 2023 are regional growth rotation away from the U.S., at least temporarily toward China, and greater differentiation with high beta FX.”

The Outlook for the Euro

In 2022, the euro weakened as much as 17% versus the dollar intra-year, plunging below parity for the first time in two decades in July. However, lower gas prices and positive growth momentum in the region are expected to boost the euro’s fortunes in 2023.

Back in November 2022, J.P. Morgan Research took a dim view of the euro, with euro/dollar forecast to hover around 0.95-1.00 in 2023. A few months on, each of the motivating factors for this downbeat view has been challenged, if not reversed outright. Title Transfer Facility (TTF) gas prices, the key benchmark for gas prices in Europe, have collapsed to pre-invasion lows as the continent experiences the warmest weather on record. This sharp fall in gas and electricity prices benefits the economy overall and should mean the region can avoid the harsh recession that was expected. In light of these developments, J.P. Morgan Research expects euro/dollar to approach 1.10 in March 2023, before declining to 1.08 in September 2023.

“Energy dependence and geopolitical risks will be a theme for the region for years to come and simmering U.S. recession risks still pose a threat to growth trade. Also, the Fed might have to deliver more rate hikes, resulting in further ECB tightening,” noted Chandan. “As such, even though we think near-term growth momentum suggests 1.10 could be broken, we do not yet pencil larger gains for the second half of 2023.”

The Outlook for the British Pound

Similar to other major currencies against the U.S. dollar, the sterling is being battered, tumbling to record lows in September 2022 after the Truss administration announced a series of tax cuts. While a new prime minister has since taken over, J.P. Morgan Research remains bearish on the pound.

While sterling has strengthened meaningfully versus the dollar in recent weeks, it was also the second worst performing currency in the G10 — a group of 11 industrial countries that meet on an annual basis to discuss economic and financial matters — versus the dollar through the turn of the year. “Markets are still pricing the pound as an underperformer and we think that should continue,” said Patrick Locke, Global FX Strategist at J.P. Morgan.

Looking ahead, J.P. Morgan Research projects broad underperformance for the pound in 2023, with sterling/dollar forecast to reach 1.20 in March 2023, before falling to 1.18 in June 2023, to 1.16 in September 2023 and to 1.15 in December 2023. “There are still very solid reasons to see sterling as a relative underperformer in the G10 space. Stagflationary dynamics remain, growth risks from the U.S. are relevant, housing market weakness might just be getting started, consumers are struggling with negative real wage growth, and the labor market is facing a lose-lose scenario,” noted Locke. “Although the U.K. has some exposure to the drivers of better European growth, namely lower gas prices, it is also perhaps less primed to benefit from this given lower trade intensity with the continent post-Brexit.”

The Outlook for the Japanese Yen

The dollar/yen pair breached 150 in October 2022, marking a 32-year low. This was largely due to Japan’s yawning trade deficit and the Bank of Japan’s (BoJ) dovish stance. While the Japanese yen closed out 2022 almost 18% down versus the dollar, J.P. Morgan Research has been expecting it to strengthen in 2023.

“A decline in long-end U.S. yields and a peaking out in terminal rate expectations into 2023, alongside the risk of a moderate U.S. recession, should clear the runway for a lower repricing of the dollar/yen pair in 2023,” said Benjamin Shatil, Head of Japan FX Research at J.P. Morgan. In addition, the BoJ shocked markets in December by relaxing its yield curve control (YCC) policy of pinning yields close to zero. This move was in line with the J.P. Morgan Research view, but the timing was earlier than expected. The central bank announced it would allow 10-year Japanese yields to climb as high as 0.5 percent, compared with 0.25 percent previously. The yen strengthened against the dollar after the news.

“What has changed for the yen has been the earlier-than-expected BoJ pivot. Our baseline macro view now looks for a further relaxation of YCC later this year, which would form an additional bullish tailwind for the yen,” said Shatil.

Though this would mark a major change for BoJ policy, other tweaks may also prove supportive for the currency. These include a further revision higher of the central bank’s core CPI forecasts and a change to the extant forward guidance (official communication that signals to the public the likely future path of monetary policy). All in all, J.P. Morgan Research expects the dollar/yen pair to trade at 128 by December 2023.

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