In 2022, the USD has been turbo-charged by geopolitics! Will this continue in 2023? Yes!
The economic transformation is set to continue. Ever since this decade started, a number of long-term transformations came into play. These changes are significant, whether it’s global trade taking a new shape with the reshoring or alterations in political, societal, or environmental conditions. During periods of major change, investors rarely feel comfortable with change. At the same time, Central Banks are determined to reduce inflation, while the transition to ESG and carbon neutrality will require significant new investments and R&D.
For now, the markets are expecting the USD to top out by mid-year. This consensus view is based on the fact that most analysts believe that the US economy will be weakening while others will be running into a recession, mainly in Europe. At the same time, the consensus view is lower growth than expected in Asia, especially for China. So the broader play at work here is deleveraging, lower corporate profits, a weaker credit cycle, and lower corporate profits. FWD EPS expectations are expected to be adjusted by another 20% downwards. Given this and that financial models don’t really work well during periods of uncharted stress, investors may feel uncomfortable taking on risk exposures for a given period of time. Only once Central Banks start easing again and governments indicate they are anticipating limiting their fiscal dominance will investors’ sentiments change for the better.
In that light, we might expect the following scenarios:
- More of the same (USD to become stronger): The market sees strong data, especially from the US, less from elsewhere. The interest rate differential is therefore to increase, which should further materialize some USD strength.
- Recession fears are rising and US yields falling: Under these circumstances, the market would anticipate the FED to reduce interest rates rapidly, but because of lacking alternatives, investors are expected to stay square with the USD being well supported. The major play here would be to favor safe haven status assets given the present widespread risk aversion.
- Inflation remains stubbornly high while economic growth remains strong: Against the general view of an oncoming recession, this is probably the scenario that could unfold in 2023. This point of view is particularly interesting as China is progressively moving away from its restrictive COVID policies. This, in turn, will stimulate demand for base materials, so an increased demand in US dollars. Furthermore, yields would have a hard time falling; therefore, investors would continue to seek benefits from yield differential and the USD safe haven status.
In terms the of the major FX pair (EUR/USD), this could result into the following:
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Event |
FX Impact | ||||||
| Macro top-down assumption | CB tightening | EU Energy crisis | China economic issues | Global risk | EUR/USD Outlook (Q123 / Q1/24) | |||
|
Scenario |
Blue-Sky | Fed rates to peak at 4.5%, start cutting | Peace in Ukraine | China is done with Covid | Risk-on | 1.08 / 1.18 | ||
| Mixed | Fed rates to peak at 4.5%, stay put | Gas flows again for winter 23/24 | PBC to implement fiscal stimulus | Investors see the light at the end of the tunnel | 1.00 / 1.08 | |||
| Some more pain | Fed rates to peak at 5%, stay put | Energy shortage in Europe | Covid restrictions to continue, real estate market to impact growth | EM in trouble, USD to stay strong | 0.95 / 1.00 | |||
| Geopolitics still hard at play | Fed rates to peak at 6%, stay put | UA-RU conflict to extend into Eastern Europe | Covid, real estate, and exports issues hit the Polit Büro which tries to rescue itself by invading Taiwan | Further risk-off, Dollar is king, EPS are down, investor lose confidence | 0.90 / 0.80 |
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