We think that a slower pace of Fed tightening, China’s reopening and a less dire outlook for Europe as well as continuing tightening by other G10 central banks justifies further USD weakness in 2023. That said, we also expect that the USD sell-off will slow down noticeably and even go temporarily into reverse in the coming months. The USD could be more pronounced vs the CAD. We also continue to expect the USD to bottom out around the end of 2023 when easing financial conditions and a recovering economy in the US as well as more favorable asset valuations attract investors back into the USD.
The CAD ultimately fared more like other commodity FX than a USD proxy in 2022. This could reverse this year, as the CAD is yet to price in the terms-of-trade shock vs the USD, while it may underperform the rest of the commodity bloc due to less favourable geographical and product exposure. Furthermore, given the BoC’s announcement to hold interest rates should weaken the currency against the USD. Look for the USD/CAD to trade between 1.35 – 1.37 in the short term.
While the recent EUR/USD gains have been exaggerated and could be followed by a correction lower in the very near term, we think that the mix of drivers behind the currency pair would remain largely positive, allowing it to regain more ground in the next 6-9M. On the EUR/USD positive side, we expect repatriation flows out of the USD and back into the EUR to continue on the back of higher EGB yields and contained sovereign credit risks. We further note that stable global energy prices and the reopening of the Chinese economy could help stem the deterioration of the Eurozone trade deficit. On the EUR/USD negative side, we expect that the Eurozone energy crisis will remain a key drag on the Eurozone outlook.
The GBP remains the worst G10 currency. We further think that FX investors will continue to see the GBP as a useful recession and stagflation hedge and doubt that the currency will recover further without the support of real UK rates and yields. We also worry that negatives related to the unfolding UK recession will be made worse by the fresh fiscal austerity measures of the Sunak government and the persistent energy crisis. Moreover, the deteriorating UK external imbalances as well as worries that the BoE is falling behind the curve could come to haunt the GBP again in the coming months.