2023 is expected to be a challenging year. The energy crisis continues to affect Europe, inflation will remain high until 2024, and the scenario of an economic recession seems imminent.
The currency market is expected to react to these factors by increasing exchange rate volatility, with negative effects on companies’ financial situations. Analysts at iBanFirst, one of Europe’s largest providers of foreign exchange and international payments, explain the main trends that will influence the global economy as well as the activity of importers and exporters in 2023.
- Currency volatility changes the competitive game
Exchange rate volatility has a direct impact on general economic conditions and in particular on the supply chain. And the United States could be most affected this year. For example, with such a drop of the yen against the dollar (minus 14% since 1 January), it has become much cheaper to produce in Japan than in the US, whereas in the past, production in Japan was more expensive compared to the US. If this situation continues, it is likely to lead to a relocation of production facilities close to customers.
As volatility in the foreign exchange market tends to increase, iBanFirst analysts recommend Romanian companies to adopt measures to protect themselves against currency risk in order to maintain their competitive advantage on international markets.
„Currency market volatility is far from being a problem for multinationals. It can affect any company, regardless of size, with cross-border operations. The implementation of a currency risk management strategy should be considered by a company in the following situations: it either invoices its exports or business-related costs in foreign currency (subsidiaries, salaries, etc.), pays for imported goods or services in foreign currency, or has purchase commitments to foreign suppliers“, says Alin Latu, Country Manager iBanFirst Romania.
- USD liquidity, the underlying factor
The evolution of USD liquidity is of prime importance since we operate in a dollar-based world. It deeply influences the direction of the economy and financial assets. There are several ways to calculate USD liquidity. A common practice is to track the evolution of USD money supply in major economies.
USD liquidity surged to a record high in the Covid period with central banks opening massively the credit tap. But since then, things have changed. The comeback of inflation has forced central banks to embrace a more restrictive monetary policy. Even the Bank of Japan, which stood apart for a long time, has signaled this week it could begin to move away from years of ultra-loose policies to tackle above-target inflation. This results in a contraction of USD liquidity:
„According to our estimates, it is now back at levels reached in 2015 when China devalued the yuan. Given inflation will probably not disappear overnight, thus forcing central banks to remain in the hawkish camp for quite some time, expect the contraction to continue at least in the short-term meaning Q1 or even Q2 2023“, adds Alin Latu.
- A breather for emerging countries: short-term dollar depreciation
Since its 10-year high around the 114 area at the end of September, the dollar index is following a marked downward trend. If the decline continues, this would be good news to start 2023. A strong dollar is a net negative for the global economy. It is reverberating through balance sheets around the world. According to the International Monetary Fund, approximately half of all cross-border loans and international debt securities are denominated in U.S. dollars. Emerging markets are usually the most vulnerable, especially the private corporate sector which tends to have high levels of dollar-denominated debt. As global interest rates rise, financial conditions have tightened considerably for many countries. A stronger dollar only compounds these pressures, especially for some emerging markets that are already at a high risk of debt distress.
- Euro/dollar, a new scenario
The narrative has also drastically changed on the eurozone currency in less than three months. At the end of September, the EUR/USD reached its lowest point in 20 years around 0.95 (which is consistent with the dollar index peak, of course). It is now hovering around the area between 1.06 and 1.07. This is not completely surprising. When net positioning in the euro is extreme –see in the below chart showing FX traders positioning at the end of September – usually a strong rebound follow.
In this specific case, it has also been fueled by monetary policy (hawkish European Central Bank) and better than expected fundamentals (the energy crisis in Europe is not as bad as feared). In the short to medium-term, positive sentiment is likely to continue to dominate. But the EUR/USD has to build a lot of energy to pull clear of the 1.0775 zone which serves as a weekly resistance. This might be complicated in the absence of real market movers in the next period.