FX Talking: Winter wonderland
FX and financial markets in general are drifting into year-end on the assumption that central banks will soon be ready to sound the all-clear on inflation and deliver benign easing cycles to ensure a soft landing. We doubt it will be that easy
It's a wrap
In this December edition of FX Talking, we bring together our final thoughts for the year on FX markets. Not too much has changed since we published our 2023 FX Outlook: The dollar’s highwire act, but clearly high-profile central bank meetings and inflation data this month will set the tone for 2023.
In the G10 space, the core story will be how far EUR/USD needs to rally. Our preference is that EUR/USD will struggle to sustain gains over the 1.05/1.06 area – although thin year-end markets could dictate otherwise. Our core view is that the market has priced in too much US Federal Reserve easing for 2023/24, US yields will rise and EUR/USD can make a bid for parity early next year – a time when the dollar is seasonally strong.
Currencies we like in the G10 space are the more defensive Japanese yen and Swiss franc, while sterling and the Swedish krona look to be some of the more vulnerable in the early part of the year. Again it looks too early for a broad rally in commodity currencies, but we continue to favour the Canadian dollar here.
As we discussed in our recent Directional Economics, the Polish zloty should grab the limelight from the Hungarian forint in the EMEA space. Questions over appropriate monetary policy and whether Poland can negotiate access to its full EU funds in an election year will dominate. The 2023 elections in Turkey will also feature prominently in emerging market diaries.
In Asia, the focus will be on whether China can exit its zero-Covid policy in an orderly manner and whether domestic demand growth will be enough to offset a weak external environment. USD/CNY may not need to return to the 7.30/7.40 area, but an orderly decline does not look likely either.
Fiscal fundamentals are the challenge in Brazil for 2023. And despite the Brazilian real’s very positive real interest rates, we worry that core rates going higher into a recession can cause more trouble for EM currencies – including Brazil. We continue to favour the Mexican peso for its low volatility carry.
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