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By Mark Sobel January 5, 2023
The dollar's trajectory is set for continued dominance in the global foreign exchange market.
In recent years, speculators and macro hedge funds have found ample opportunities to turn a profit by navigating the volatile waters of currency markets. However, success was often contingent upon aligning with macroeconomic trs. John Maynard Keynes famously lost significant sums betting on currencies, nearly bankrupting himself at times. Even for those who correctly forecasted currency movements, missing critical timing could prove disastrous.
Nevertheless, in 2022, the elite of macro hedge funds were celebrated anew as 'swashbuckling masterminds'. Success came largely by simply taking long positions in the dollar and short positions on virtually every other major currency agnst the backdrop of U.S. Federal Reserve rate hikes and the energy market shocks from Russia's invasion of Ukrne.
For 2023, a different scenario is likely to unfold. The value of the dollar may remn historically strong but might experience notable downward pressure by year's .
The current trading-weighted value of the dollar suggests it has already peaked relative to major currencies as the Federal Reserve approaches its projected interest rate range and reduces large-scale hikes beyond 75 basis points. Despite this, it remns significantly overvalued agnst these peers. The United States will also have to finance a sizable current account deficit estimated at around 3 to 3.5 of GDP in 2023-a slight decrease from the nearly 4 seen in 2022.
While these factors might seem conducive to a sharp decline in the dollar, the market may not easily surrer this advantage early on, especially before mid-year 2023.
The outlook for monetary policy uncertnties loom large over foreign exchange traders' prospects. In particular, predictions of U.S. inflation outcomes will require nimble parsing of Federal Reserve data releases throughout the year. Core inflation could prove challenging to bring down convincingly towards the central bank's target of 2 without a robust labor market and buoyant service price growth. The dot plot suggests that may cause the Fed to lift interest rates above market expectations throughout 2023 and mntn them, thus supporting capital inflows into U.S. assets.
However, if there is a more rapid decline in services inflation than anticipated-a scenario made more likely by recessionary forces-the dollar could find itself under downward pressure.
Overall, given the Fed's stance, especially during the first half of 2023 should modest recessionary pressures prevl, foreign exchange bets may remn clouded and timing judgements increasingly difficult. Only time will reveal who truly masters this treacherous market.
Mark Sobel serves as US Chr at OMFIF.
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