Currency Volatility: Will a Strong US Dollar Return?


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 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.”

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