The US dollar continued to gain strength in 2022, largely due to the hawkish policy adopted by the Federal Reserve in response to soaring inflation.
The Fed lifted the federal funds rate—which effectively dictates the cost of money in the US economy—from near zero at the beginning of 2022 to its current range of 4.5% to 4.7% at the January Federal Open Market Committee (FOMC) meeting.
The strength of the dollar isn't just about Fed policy. While many experts believe the US economy is headed towards a recession, the outlook of other advanced economies such as the UK, Europe and Japan might be even less attractive.
Additionally, geopolitical risks have plagued the global economy—particularly China due to its zero Covid-19 policy (which ended only recently) and bursting real estate bubble last year.
These factors drove investors to safe-haven investments like the US dollar in 2022.
With the first quarter of 2023 coming to a close soon, AsianInvestor asked asset allocation and currency specialists for their predictions on what currency could take the crown of top performer this year.
The following contributions have been edited for clarity and brevity.
James Athey, investment director of rates management
Broadly, we would agree that by end of the third quarter of 2022, the US dollar was over-valued and over-positioned. We would also agree that over the medium term the dollar is likely to weaken.
We suspect however that the big dollar down-move is still some distance away – because of the cyclical nature of the dollar.
While the bulk of the gains from the Fed’s aggressive monetary tightening have been had we believe that the dollar has one last leg higher to come – that which occurs at the very end of the cycle when the global economy goes into recession and risk assets are forced to countenance the significant drop in earnings which will result leading to a flight-to-quality bid for the dollar.
This gives us a somewhat V-shaped forecast for the dollar with the timing of the inflection very uncertain. That makes picking a best performing currency difficult given the dominant role which the dollar plays in driving FX returns.
I have selected the Mexican peso as my best performing currency of 2023.
It is a high-yielding, high quality currency where both fiscal and monetary policy have been highly orthodox and there is likely to be considerable inward foreign direct investment flows flows as a result of global and US corporates’ trend towards on-shoring and friend-shoring in this unstable and uncertain economic and geo-political environment.
The peso has also demonstrated a remarkable ability to perform in both strong and weak dollar environments in recent months – a dynamic which looks set to continue.
John Bradley, head of foreign exchange
BNP Paribas Asset Management
We believe that 2023 will see central banks continue to hike aggressively until they believe that they have inflation firmly under control.
It is highly likely that policy makers will have to tip economies into recession in order to achieve their inflation goals. In that environment, we believe counter-cyclical funding currencies and safe havens will end up being the outperformers by the end of 2023.
Specifically, we favour continued US dollar outperformance and a resurgence in the Japanese yen.
Although the US dollar reached historically stretched levels on many valuation models in 2022, we believe that the dollar will continue to benefit from a relatively aggressive hiking cycle from the Federal Reserve.
In our view, it is likely the Fed will be forced to hike to at least to 6% in order to achieve their inflation targets. Other central banks are unlikely to be able to match the Fed’s pace. Therefore, we expect the dollar to benefit both from yield differentials and its safe-haven status if the global economy tips into recession.
The Japanese yen is likely to benefit later in 2023 as we believe the Bank of Japan will eventually end its yield curve control policy and that Japanese bond yields will rise.
Given our view that global growth is likely to struggle in the second half of 2023, we would also expect the yen to resume its traditional outperformance during periods of slowing global growth and risk aversion.
Catherine LeGraw, asset allocation portfolio strategist
While many forces may drive currencies from fair value in the short-term, valuation is a strong driver over a longer horizon.
Attractive currencies, when assessed on a purchasing power parity (PPP) valuation metric, include the Japanese yen, euro and Swedish krona across developed markets.
Attractive emerging market currencies include Brazilian real, Korean won and Mexican peso.
One way to profit from attractive currencies is through unhedged investments in the local market equities.
Equity investors in countries with undervalued currencies have two ways to win: currency appreciation or superior fundamental performance of the stocks.
Cheap domestic currency can feed into an improvement in competitive advantage, and thus the underlying fundamentals for corporations in countries with cheap currencies tend to outperform those with expensive currencies.
Another way to benefit is via a long-short strategy that takes relative-value positions across currencies based on valuation; for example, a global macro strategy, which may also have the benefit of diversifying the overall portfolio.
Nordine Naam, global FX-EM strategist
Despite the dollar's rebound since February, we remain negative on the dollar for the year, particularly in the second half of the year when the US economy will show more signs of slowing activity.
In this environment, it will be mainly the cyclical G10 currencies and the emerging currencies that will rebound, as we saw between October 2022 and January 2023, especially if the Chinese economy picks up, even if at a slower pace than expected.
Among the G10 currencies, the Australian dollar has significant rebound potential on the back of stronger China growth and iron ore.
Among the emerging currencies, we find Latin American currencies such as the Chilean peso and Mexican peso could outperform, supported by high interest rates.
In Asia, the Thai baht is expected to outperform with the expected normalisation of tourism, while in Europe, Middle East and Africa, the Turkish lira could appreciate sharply if President RT Erdogan loses the general election in June.