The US dollar has weakened against its peers in the first month of 2023 as the Federal Reserve fades as the main driver of currency markets and investors focus on the policies of other major banks power stations.
The Fed’s big rate hike campaign captivated investors in the first nine months of 2022, sparking a run on the dollar. But as the US central bank slowed its borrowing cost increases, the currency slid against its peers.
The dollar fell 1.4% in January against half a dozen major currencies, leaving it on track for its fourth straight monthly decline. It is now trading at levels last seen in May 2022.
“The Fed is no longer in the driver’s seat – and you see that playing out across the FX space,” said Mazen Issa, senior FX strategist at TD Securities. Once the Fed signaled that it would end its 0.75 percentage point rate hike in December, “the Fed effectively decided to cede policy leadership to its global peers.”
Elsewhere, central banks have picked up the slack, including the European Central Bank and the Bank of Japan. The ECB is expected to stick to extra-wide rate hikes while the Fed downgrades. For the BoJ, the rise in interest rates may still be a long way off, but the easing in December of its policy of setting long-term bond yields near zero has fueled speculation that the era of the Japan’s ultra-loose monetary policy is coming to an end.
This more hawkish outlook has helped strengthen both the yen and the euro, which are back to their highest levels since the spring of 2022. Monetary policy decisions by the Fed, ECB and Bank of England next week could provide further clues to the Fed’s will. relinquish its leading position this year.
“2022 was the year that everything lined up for the dollar. The Fed was leading the charge with interest rates, and the war in Ukraine and zero Covid policies in China resulted in favorable shocks on the All of these things happened at the same time,” said Alan Ruskin, chief international strategist at Deutsche Bank.
High costs of raw materials like natural gas and oil have made 2022 difficult for economies that rely heavily on imported raw materials like Europe, the UK and Japan. Their ratios of import prices to export prices – known as their “terms of trade” – were dismal, showing more and more capital leaving these markets, weakening their exchange rates. But this year’s winter was warm and this trend did not progress as far as expected, keeping natural gas demand in check.
“The terms of trade story has turned in favor of Europe, UK, Japan – the commodity importing countries. They now have much better prospects than before,” Shahab Jalinoos said. , Global Head of Currency Strategy at Credit Suisse.
Lower commodity prices have also changed growth expectations outside the United States. Deutsche Bank on Tuesday revised its European growth forecast upwards, from expectations of a 0.5% contraction to a 0.5% expansion in 2023. “Gas storage is up and prices gas are down. Inflation is down and uncertainty is decreasing. As such, we can remove the recession from our forecast for 2023, adjust headline inflation downwards and reduce the deficit,” said Deutsche Bank economist Mark Wall.
Conditions are also improving in China, where the government scrapped its zero-Covid policy, a move that should support its economy after last year saw one of its weakest performances on record. The effects of the reopening on the foreign exchange market should be mixed, however, as stronger growth could also push up demand for commodities, leading to higher global inflation.
The greenback’s central place in global finance means that when it rose last year, it put pressure on economies around the world, especially in developing markets which often pay for imports in dollars and borrow in the currency. Its reversal this year has helped fuel a turnaround, with an MSCI basket of developing market currencies up 2.4% in 2023.
“The catastrophic dollar loop that markets were so worried about last year has turned into a dollar boom loop,” said Karl Schamotta, chief market strategist at Corpay.