What to expect from Forex in 2023?

The US dollar - Forex king dethroned?

Looking at the development of the dollar index, it is clear that the downward trend has been prevailing on the chart since the end of September. Even so, the index is still at long-term above-average levels, so the dollar could still weaken slightly this year unless a black swan intervenes in the market. Of course, the strength of the US dollar will also depend on the Fed's actions. The Fed is expected to raise interest rates at least twice more - the market expects two 25 basis point hikes. If the Fed meets expectations, even higher interest rates may not make the dollar more attractive - it is already virtually priced in by the market. The surprise would come if the Fed raises rates by 50 basis points at the next meeting, then the dollar could strengthen more significantly, across currency pairs.

By the end of the year, then, the market expects one or two interest rate cuts in the US, which is absolutely inconsistent with the speeches of Fed officials. They do not foresee any cuts this year. However, we still expect the dollar to continue to weaken this year, perhaps toward the levels of last February. In the long term, there is talk that the US dollar is set to lose its privileged position and also its 'petrodollar' designation - the currency in which most of the world's oil is traded. However, if the dollar were to lose its privileged position in the oil market, it would certainly not be immediately. While Saudi Arabia and China have already introduced the petroyuan, we cannot expect the introduction of the 'petroeuro' in Europe, for example, and let’s not forget that the US is still by far the largest oil producer.
 

_{Dollar index DXY on D1 chart in MT4 platform}

Euro - same old song

Europe is probably out of the woods. Fortunately, the energy pincers that Russia has clamped over it have not fully closed. At least for now. Although energy supplies have been secured from elsewhere, Europe may still have to get used to significantly more expensive energy in the long term. This could cause problems for industry and the labor market in the longer term.

Europe is not yet a winner. Moreover, inflation in the euro area is still above 9% and the ECB cannot ease up on its interest rate hikes. Unlike its US counterpart, we expect the ECB to raise interest rates by 50 basis points this week. The tightening cycle is then likely to continue until March. For the euro, the market is thus expecting rather a continuation of the appreciation that already started in August. Similar to the dollar, we have a euro index at Purple Trading that reflects the current value of the euro against a basket of foreign currencies.
 

_{Euro index EURX on D1 chart in MT4 platform}

Japanese Yen - a surprise on the horizon?

The Japanese yen has been significantly weakened by the Fed's interest rate hikes over the past year on the pair with the US dollar. Since October, however, it has tended to strengthen against the major currencies. In fact, the Bank of Japan has de facto raised interest rates by controlling the yield curve of the 10-year government bond (YCC), whose yield could have been in the +- 0.5% band at the end of the year. With inflation having at least temporarily broken out of a 10-year lull and jumped to levels above 3%, Japan had no choice but to intervene to support the yen. Its significant depreciation was causing inflation to rise further.

Governor Haruhiko Kuroda, the main proponent of a permanently very loose monetary policy, will step down this spring. His successor may further "tweak" the YCC framework (perhaps into the +- 0.75 band), which is likely to further strengthen the yen. We expected this at the last Bank of Japan meeting, but to no avail as the Bank of Japan did nothing. So with a change of central bank leadership, there could be a huge surprise - not only could the 10-year yield curve control be lifted, there are even rumors of a potential base rate hike. The Bank of Japan is the last central bank that still maintains a policy of negative interest rates. However, multiple interest rate hikes are highly unlikely - the central bank will remain sensitive to excessive yen gains as these could raise the specter of a return to deflation. Thus, on USDJPY, we expect rather a continued strengthening of the yen, and the exchange rate of this currency pair could even be below 120 by the end of the year.
 

_{USD/JPY currency pair on D1 chart in MT4 platform}

How do the big banks see it?

The world's banks' outlooks on Forex are abundant, so in the table below, we present ING's assumptions for 2023. The latter is rather skeptical and expects a renewed energy crisis in Europe, a second wind in the US dollar, and a lot of volatility. So take a look at ING Bank's overview of the major currency pairs for 2023. More information on the assumptions can be found here.