Currency Outlook Fourth Quarter 2023

By David J. Grimaldi, TM Foreign Exchange Sales Consultant

The September message from the Fed was not what the markets wanted to hear. While the Fed left rates unchanged, it announced that one more rate hike is likely. Rates should remain higher for longer, as the Fed's dot curve pushed expectations for rate cuts further out. The market is pricing rates to stay above 5% through next year. This sentiment changed often during the summer and will likely change again in the coming months. The Fed also pushed out expectations for a recession to 2024. Oil prices are rising again, which should factor into the inflation data in the coming months. Economist Paul Krugman was a little early in calling inflation beaten in June, as it historically has proven to have peaks and valleys and to remain sticky longer term. The U.S. dollar has benefited from the recent sentiment, as the European Central Bank has signaled; it may be done with rate hikes, since its economy is doing worse than the U.S.

The United Kingdom left rates unchanged for the first time in almost two years and has promised a pause to see if inflation remains elevated. While we could see more dollar strength in the near term, I would expect to see corrections, as another hike in the U.S. has been priced in to achieve these levels.

EUR/USD

Source: TradingView

Last quarter, we saw a steep decline in the EUR as recession fears for 2023 waned in the U.S. EUR/USD has appreciated nearly 18% since October 2022, reaching a high of 1.1275 in July 2023. We did not achieve my expected target of 1.1400 in Q3. Instead, we saw nine weeks of EUR depreciation to a low of 1.0633 in September. There are a number of reasons to expect some EUR gains into Q4. The Federal Reserve is expected to hike rates one last time, and inflation in the Eurozone is still strong. While fuel prices are rising again (oil is up 33% since July), core inflation in Europe has only dropped marginally since April. The additional rise in energy costs should keep inflation high and Europe hiking rates beyond the U.S. timetable. The downside for the EUR is the war in Ukraine, as it is evident that the longer it persists, the more likely the outcome will favor the Russians. The U.S. is still not discussing diplomatic solutions, and neither Democrat nor Republican leadership hold the position of driving the Russians completely out of Ukraine.

GBP/USD

Source: TradingView

The United Kingdom has held the distinction of having the worst inflation in the Group of Seven countries. September brought relief as the Consumer Price Index dropped to 6.7% from the expected 7%. The drop has given some the belief that the Bank of England may not hike rates at the next meeting. Some factors are improving in the British Isles that could lead to the attractiveness of the pound going forward. For one, the Windsor Framework has improved the movement of goods for business between Ireland and Great Britain. Nevertheless, the Bank of England will continue to aggressively raise the bank rate on short-term bond yields to combat inflation, and it will continue buying longer dated securities from these levels going forward.

USD/JPY

Source: TradingView

This Japanese yen weakened over the last quarter, reaching my target level of 147, and is currently pushing 148. However, it is hard to remain bullish at these levels, as the Bank of Japan (BoJ) intervened last year to protect the yen by selling dollars. The anticipated moves by the BoJ to abandon ultra easy policy may be ending soon. The BoJ’s Kazu Ueda said there is a possibility of removing negative interest rates if increasing wages and prices become unsustainable. The volatility of the yen will further the decision to abandon negative rates. In September, currency czar Masato Kanda hinted of a coordinated intervention, which would possibly include the U.S. to sell dollars. While inflation has been modest compared to the rest of the G7 at 2%, the risk of an excessively weak yen could lead to inflation and high import prices.

USD/CAD

Source: TradingView

Higher gas prices have added to the inflation outlook in Canada and could prompt another rate hike by the Bank of Canada in October by 25 bp to 5.25%. Other G7 countries have not yet seen the impact of higher oil prices in inflation data, even as oil approaches $100 a barrel once again. Oil is the main export in Canada and has a high correlation to Canadian dollar strength. Even though Canada may have already entered a recession, past moves by the Bank of Canada indicate it will focus on the inflation trend and continue to raise rates.