G10 FX Year-in-Review
- By Ben Ford and Richard Jones
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Summary
- The major G10 currencies – the US dollar, the euro, the Japanese yen, the British pound, and the Swiss franc – have had varying performances in 2023.
- USD declined during the first half of the year, before rebounding sharply from July-October, and has traded lower in Q4.
- EUR rallied from January to July, giving back some gains through October, and has rallied modestly in Q4.
- JPY spent most of 2023 in a sharp downtrend, rebounding sharply after bottoming out last month. It is among the cluster of the strongest currencies since mid-November.
- GBP has been one of the two strongest currencies throughout 2023, although it has started to drift lower in recent weeks.
- CHF is the strongest performer in the G10 in 2023, with the currency hovering near the all-time high set this month (on a trade-weighted basis).
Market Implications
- We expect USD to continue its Q4 down move into 2024, with JPY, EUR, and CHF to appreciate against the greenback.
- We expect GBP to underperform the other G10 majors in 2024.
Introduction
The major G10 currencies – the US dollar, the euro, the Japanese yen, the British pound, and the Swiss franc – have had varying performances in 2023.
Here is a breakdown of each of the currencies’ performance this year.
US Dollar (USD)
After 12 months of ups and downs, the US dollar index (DXY) is down about 1% this year, currently trading just below its mid-point and average price for 2023.
The high/low for USD was established between mid-July (the low) and early October (the high), with the 8% climb during that period arguably being the most notable move of this year.
Since peaking on 3 October, the DXY has retraced about 65% of that up move, currently trading at its lowest level since August.
The key question is: what happens now with the dollar?
We would argue that a big driver of the July-October upmove was the favourable interest rate differentials for USD combined with superior US economic growth prospects.
We would also argue that the unwind of the July-October rally was primarily due to the material dovish repricing of Federal Reserve (Fed) expectations for 2024.
That repricing gathered pace with the Fed’s policy announcement last week, with the FOMC’s dot plot turning much more dovish.
On 3 October, the Fed Funds Effective Rate (FFER) was expected to drop to 4.74% by the end of next year (from the current 5.33%). Now, the FFER is priced to drop to ~3.9% by the end of 2024. That’s a big reprice in a very short space of time (with just over 30bps of that reprice happening last week).
These much more dovish Fed expectations are the major contributing factor to the USD’s decline since the October peak. Since then, USD is down versus all its G10 counterparts.
The Fed, together with the European Central Bank (ECB), is now priced to be the most dovish G10 central bank next year. Both policymaking bodies are now priced by markets to cut rates by ~140bps.
As such, each of the major USD pairs are expected to see modest dollar downmoves next year. USD is expected, on average, to drop ~1-6% against its major counterparts in 2024.
While growth across the G10 is expected to moderate considerably next year, the US is still expected to outperform its major market peers in the next twelve months.
This USD-positive metric is offset by current market pricing, which calls for deteriorating interest rate differentials for USD over its G10 peers.
This has been the big driver since October, and our view is that 2024 G10 currency forecasts are calling for these dynamics to replay through next year, leading to a modestly weaker USD.
This seems about right to us.
The Euro (EUR)
The euro is the fourth best performing G10 currency versus USD this year, up about 2.1% versus the greenback.
On a trade-weighted basis, the euro is up about 2% in 2023, currently trading near the middle of the YTD range.
It has been a tale of two halves for EUR/USD, with the pair strengthening for the first half of the year into mid-July, dropping through early October before bouncing since then to currently trade just above 2023’s average price.
While this performance broadly follows price action in the DXY (which should not be a surprise given EUR/USD’s big weighting in the index), we think it is worth pointing out some of the price action dynamics at play in the early part of 2023.
In mid-to-late 2022, EUR/USD collapsed to a multi-decade low, near 0.95.
The big driver for this selloff was fears about the impact of the Russia-Ukraine war on energy supplies to the Eurozone. This coincided with oil and gas prices lurching higher, as energy traders priced a long, cold, and expensive winter for Europe.
Once the markets realised that the worst-case scenario would not come to pass, energy prices collapsed, and the euro recovered.
This recovery led to EUR/USD rebounding sharply at the end of 2022 and into Q1 2023. The pair then range-traded for a few months before topping out in July near 1.13.
Looking ahead to next year, market pricing expects the current interest rate differentials between the US and Eurozone to remain roughly the same as now, as markets price similar amounts of easing next year from the Fed and ECB.
Economic growth is expected to be better in the US than in the Eurozone, but this is offset with a generally positive expectation for global equities next year.
This buoyant equity view should be euro-positive (as our colleague Bilal Hafeez showed recently).
Failing a major shift in interest rate differentials (which is currently not priced by markets), this should lead to the modest gain for EUR/USD that market-consensus forecasts currently call for.
The Japanese Yen (JPY)
The Japanese yen is the worst performing G10 currency versus USD this year, down about 8.5% YTD versus the greenback.
On a trade-weighted basis, JPY is down about 9.5% YTD, although it has bounced off the 2023 trough in the past month or so.
We argue that the yen’s underperformance against all G10 currencies is due to the Bank of Japan (BoJ) monetary policy being out-of-step with its counterparts.
While the rest of its peers have been engaged in the most aggressive tightening cycles in a generation, the BoJ has kept its monetary policy highly accommodative, with its sub-zero policy rate well below that of the other G10 central banks.
Recently, there has been speculation that the BoJ will end this sub-zero policy stance. This speculation, together with dovish Fed repricing, has seen JPY reverse some of its 2023 weakness.
Since USD/JPY peaked this time last month, the yen is among a cluster of the strongest G10 currencies, with USD/JPY down 6% in that period.
This JPY strength is expected to continue into next year, with the average expectation calling for a 6% decline in USD/JPY. We agree that yen strength is likely, and that USD/JPY can continue the march lower seen over the past month or so.
As interest rate differentials in favour of the dollar have driven USD/JPY higher most of this year, interest rate differentials moving against the dollar should see the pair decline next year.
If the market is right about the Fed, the current 500+bps differential between the Fed’s policy rate and the BoJ’s policy rate will narrow to below 400bps.
This is true even if the BoJ does not shift its policy rate. Currently, the market prices modest tightening (~20bps) by the Japanese central bank next year.
In terms of USD/JPY’s direction, whether the BoJ reverses its sub-zero policy rate is less important than what is priced for the Fed.
And with Fed pricing as dovish as it is, USD/JPY downside beckons in 2024.
The British Pound (GBP)
Sterling is the second best performing G10 currency so far this year, trading about 4.8% higher versus the USD. Looking ahead to 2024, further GBP strength is one of the consensus forecasts we disagree with.
The average expectation is for GBP to rise about 3% versus USD. We think this sterling forecast is too bullish.
The main reason for our scepticism is that we think the market is mispricing the Bank of England (BoE). Currently, the UK central bank is priced to reduce rates by about 120bps in 2024.
We think this is much less than the BoE will deliver, especially given that the market prices about 150bps of easing for both the Fed and ECB in 2024.
As our colleague Henry Occleston wrote recently, the market has made too much of recent ‘hawkish’ commentary from BoE officials.
Henry says that the BoE could start cutting earlier than the market currently prices, and that messaging from members of the central bank’s Monetary Policy Committee will become more dovish early next year.
To this we add that the current spread, where the market prices 140bps of Fed and ECB easing next year versus about 100bps for the BoE, will narrow.
We think the market will price BoE expectations closer to those of their US and Eurozone counterparts. Materially lower UK yields are set to emerge early next year.
As such, interest rate differentials should weigh on GBP, leading to a weaker GBP/USD than consensus forecasts are currently calling for, and should also lead to EUR/GBP trading higher next year.
The Swiss Franc (CHF)
The Swiss franc is the strongest G10 currency in 2023, trading up ~6.7% versus USD.
On a trade-weighted basis, the CHF hovers near its all-time high.
We think there has been a few reasons why this has been the case.
As the safest of FX havens, the franc has seen a flight-to-safety from investors during all the geopolitical turmoil in Ukraine and the Middle East. Given that these conflicts look quite challenging to resolve, we can expect CHF to remain attractive to investors.
We would also argue that another reason for CHF strength is the success the Swiss National Bank (SNB) has had in combatting inflation in Switzerland (Swiss inflation already below target, with headline CPI at 1.7%, and core CPI at 1.5%). This relatively attractive inflation backdrop makes the franc attractive to investors.
Perhaps the most important driver of the strong franc this year, though, has been the SNB’s intervention to support the currency.
The central bank has seen a strong franc as a key to avoiding imported inflation and has bought CHF in the markets as part of its process of tightening monetary policy.
Looking forward, the market only prices about 70bps of SNB easing next year, so Swiss monetary policy is not seen as being as aggressive as the Fed or ECB.
They key for the direction of the franc, though, is the central bank’s approach to the currency.
In its latest policy update yesterday, the SNB kept rates unchanged (as expected) but also tweaked its language on currency intervention.
The central bank said it is still willing to intervene in currency markets, but that the SNB is no longer focusing on foreign currency sales.
While this is a significant development, we would like to monitor price action in the coming weeks to see how the dust settles from all the central bank activity last week.
Ben Ford is a Researcher at Macro Hive. Benjamin studied BSc Financial Mathematics at Cardiff University and MSc Finance at Cass Business School, his dissertations were on the tails of GARCH volatility models, and foreign exchange investment strategies during crises, respectively.