FX Update: USD stumbles into the New Year FX Update: USD stumbles into the New Year FX Update: USD stumbles into the New Year

FX Update: USD stumbles into the New Year

John Hardy

Head of FX Strategy

Summary:  The year is starting off with the US dollar on its back foot even as US treasury yields rose into year end as the market continues to believe that we are nearing the end of the Fed rate hike cycle, with easing to follow, while the ECB has grown increasingly hawkish and the Bank of Japan is seen further adjusting its policy mix under new leadership from early Q2. Will the first key data of 2023 on Friday play well with the market’s strong convictions?

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FX Trading focus: USD stumbles into the New Year, with sterling also on its back foot. The JPY has risen to the top of the heap on the anticipation of a further shift in BoJ policy after Governor Kuroda’s exit in early April.

Even with US yields backing up into year – particularly at the longer end of the curve – the market continues to express view is that the Fed is set for peak policy rates at the March or May FOMC meeting, followed by eventual cuts as soon as Q4. This has been the case for some time, with the only new information available in the last days of 2022 a particularly strong US Consumer Confidence reading for December that is rather out of synch with an anticipated dip into recession in the US. End-of-quarter and end-of-year flows may have been behind the surge in treasury yields and the weakening of the greenback, so we will need at least this week for a sense of how things are shaping up, and the most interesting test of the market’s conviction would be another batch of stronger than expected jobs and especially earnings data and another strong ISM Services print this Friday.

Another important factor for the US dollar in the opening weeks to a couple of months of this year is the debt ceiling fight and how much brinksmanship the weak GOP majority in the US House is willing to engage in. As the ceiling approaches, the US Treasury runs down its general account with the Fed, currently at $400+ billion and capable of being run down to $100 billion or less, which is a net boost to USD liquidity. Once the ceiling is inevitably raised, with or without concessions from the Biden administration, the opposite effect swings into gear as the Treasury then builds its account again, sucking liquidity out of the market.

EUR and especially JPY strength. The drivers (and some of the irony) of sharp JPY strength are discussed with the look at the USDJPY chart below. The driver of a strong euro into year-end was ECB President Lagarde finally getting religion on the inflation fight here very late in the cycle. The strongest evidence of how the market sees a divergence in the Fed vs. ECB forward is in something like the far forward 3-month short-term-interest rate contracts, which suggest that by the end of 2024, the Fed policy rate will be little more than 50 basis points above the ECB’s policy rate, at something like 3.50% for the Fed and just under 3.00% for the ECB. This has narrowed from well over 100 basis points in early November and something like 180 basis points early in 2022. A factor tempering the upside euro potential is concern that the ECB won’t be able to deliver as much as it would like for the market to believe it is capable of without triggering an ugly new aggravation of peripheral spreads as a weak economy like Italy’s can’t fund itself at 3% without QE. Italian Prime Minister Meloni has already http:been out complaining against the ECB’s communication style and the ESM.


USDJPY tanked into year-end, nearing the recent cycle lows even as US long treasury yields climbed into year-end. For most of 2022, long US yields were a very reliable coincident indicator, but the market has its sights next year on the decelerating Fed hikes that it eventually sees turning into rate cuts, while the Bank of Japan is seen further tinkering with its policy in the direction of tightening, particularly once Governor Kuroda’s replacement is found after his early April exit. Ironically, the anticipation of a BoJ shift is resulting in enormous QE to enforce the current regime. When yields were on the rise last year and the US 10-year yield first hit the current level of 3.85% in late September, the USDJPY rate was near 145.00. From here, the current USDJPY trajectory can only find support from a follow through from the BoJ in the direction of tightening (incrementalism remains a risk there) and a world that is diving into a classic disinflationary recession, with the Fed continuing to get marked lower. The challenge for this assumption would be a far stronger than expected global economy, with resilient US activity for another couple of quarters and inflation and a fresh surge in energy prices.

Source: Saxo Group

Overnight, we got a miserable official Non-manufacturing PMI for December from China as the end of Zero Covid early last month is likely reaching peak impact now and through the next few weeks, followed by a likely strong resurgence in Chinese demand. How the Chinese policy and its economy shapes up on the other side of the early Lunar New Year holiday (January 23) will be an important factor in how 2023 shapes up.

Table: FX Board of G10 and CNH trend evolution and strength.
The US dollar and sterling starting off the year in worst shape. The latter may be a durable theme this year as the Bank of England is set for QT – a tricky proposition for a twin deficit country that will have to find buyers of its paper outside of the country. Elsewhere, the outsized JPY strength is the most prominent development as this year gets under way. It looks excessive relative to the recent rise in global bond yields. CAD is paying for the Bank of Canada’s dovishness, but oil is a bit resurgent.

Source: Bloomberg and Saxo Group

Table: FX Board Trend Scoreboard for individual pairs.

Note that the “ATR heat” is fading to light orange (second quintile of last 1000 observations) for about half of the pairs tracked here as volatility has eased in recent weeks. Will be watching USD and JPY pair status over the coming week or two for developments, which are often important on calendar year rolls, as emphasized for EURUSD in my most recent FX Update.

Source: Bloomberg and Saxo Group

Upcoming Economic Calendar Highlights

  • US Markets Closed
  • 0145 – China Dec. Caixin Manufacturing PMI

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