US Dollar Direction in 2023: Ranking of seven currencies and their drivers

What goes up must come down – the US Dollar has had an excellent 2022 at the expense of risking global trade and growth. Despite geopolitical reshuffling, Uncle Sam’s currency is used in most invoices, making its dearer value a burden. Help is on its way.

In 2023, I expect inflation in the world’s largest economy to extend its decline, putting pressure on the Federal Reserve (Fed) to loosen its foot from the interest rate brakes. The complete turnaround will likely be apparent only in the springtime but could turn into a long-term uptrend for other currencies, allowing the world to recover. 

Nonetheless, not all currencies are born equal, and while the Greenback is on course to retreat, there may be significant winners and losers. Here is my ranked list of the top seven currencies.

1 Japanese Yen (JPY)

Japan has been standing out among its developed-world counterparts – sticking to ultra-loose monetary policy while others raised rates. Interventions to buoy the Yen have had limited effect and proved costly for the country’s foreign exchange reserves. With inflation beginning to reach Japan’s shores, the Bank of Japan (BoJ) may have to finally raise rates from negative ground, and stop its ‘yield curve control’ in which it caps 10-year yields at 0.25%. 

Tightening would likely have to wait until BoJ Governor Haruhiko Kuroda steps down from his post in April. Nevertheless, speculation about such a move may force the bank to change course earlier. Investors may pile onto the Yen ahead of his retirement, potentially reversing a significant chunk of JPY’s massive losses in 2022.

The BoJ’s new management may hesitate before raising rates, which are unlikely to go above 1%. Nevertheless, emerging from submerged territory would be substantial. When the last holdout capitulates, it is a sign for other central banks to change course in the other direction. 

Speculation about BoJ policy is set to remain critical for the Yen, but this time in the other direction – up. 

2 Australian Dollar (AUD)

As it is only a matter of time until the Fed changes course on borrowing costs, it is only a matter of time until China reopens, boosting its economy, and what’s good for China is good for Australia (and the Aussie) from whom it imports a substantial amount of its raw materials. President Xi Jinping’s norm-breaking third-term approval allows him to change his policy toward importing mRNA vaccines and opting for even more stimulus. 

Even if China’s reopening remains disorderly and incoherent, the message for markets is clear – China is open for business. 

Covid-related restrictions have come on top of a crackdown on China’s highly-indebted property sector. The winds of change are also coming to that field, with initial attempts to shore up the sector. That is excellent news for Australia. 

The land down under is set to be the main beneficiary as an exporter of metals to the world’s second-largest economy. Moreover, the Australian Dollar’s fate is set to remain tied to the global stock markets, which are set to recover with Fed loosening (see more below). 

3 Euro (EUR)

The common currency has been suffering in 2022 due to Russia’s war in Ukraine, which resulted in soaring energy costs and a loss of confidence. Nevertheless, the old continent has proven capable of avoiding blackouts and maintaining itself politically. Merely holding on gives it an edge. 

The next moves heavily depend on the war. An end to hostilities would sink gas prices and remove fears of an escalation, resulting in a “peace dividend.” Yet hopes are not a strategy. 

Assuming the battles drag on for long months to come, a recession is only a matter of time. Securing gas for the next winter would be costly, forcing the European Central Bank to halt its rate hike policy, and continue shoring up Italy via the bond market. 

The old continent is defying the gloomiest scenarios – especially on the political front – but the Euro’s remarkable recovery may hit roadblocks. 

4 New Zealand Dollar (NZD)

The “kiwi in the coal mine” of the global housing bust is torn between falling dwelling costs and new demand from China. Compared to Australia, New Zealand is less dependent on China, helping the New Zealand Dollar weather the storm in 2022 – but also putting it in a less favorable position in 2023. 

One of the NZD’s advantages was being backed by a hawkish central bank. That may prove a double-edged sword. The island nation is on course to suffer a recession, even though China’s reopening is set to soften the blow. 

I expect NZD to have a looser link with global stock markets in 2023, lagging behind the Aussie in that sense as well. The fate of the housing sector will be key for the Kiwi.

5 Canadian Dollar (CAD)

The CAD may benefit from gushing Oil prices but is hamstrung by the housing bubble's implosion. The pandemic-propelled price rise of Canadian homes and a slowdown in United States demand are set to outweigh the benefits of exporting the “black gold.” 

It may also further bring into doubt the Loonie’s label as a commodity currency. I expect the link between Crude and CAD to loosen, with the strength of the US economy and the Fed’s moves to have a greater impact on the currency. Roughly 75% of Canadian exports go to its southern neighbor. 

Bubbles are bursting in Toronto, Vancouver and elsewhere – yet some of the pain is already priced, as it is already acknowledged by the Bank of Canada. 

6 Pound Sterling (GBP)

Britain’s newly minted Prime Minister, Rishi Sunak, is arguably more competent than his three predecessors, but the political trouble is far from over. 

The government will have to navigate its way between various levels of austerity – selecting between the wrath of voters and strikers and that of bond vigilantes. Alongside a gloomy central bank and lingering Brexit issues, the British Pound will likely lag behind its peers. 

Brexit is set to return as a significant market mover for Pound Sterling. Will PM Rishi Sunak strike a deal with the EU? His more conciliatory tone is promising, but his backbenchers may always rebel against him. The key to seeing a stronger GBP still lies within those adamant on Brexit, and that is not a good omen. 

7 US Dollar (USD)

The biggest is left for last. A fall in the value of the world’s reserve currency would help not only the world but also help America. It would raise corporate profits, encourage local production and help United States exports. 

I expect the trigger to be two consecutive months of job losses. Seeing a minus side besides Nonfarm Payrolls (NFP) would shift the focus away from inflation, allowing interest rates to reverse.

The upcoming year will likely see a shift from fighting inflation to fighting a recession, and it could come sooner than later. While the Federal Reserve insists it will hold interest rates high in 2023, previous pledges had to face reality. In 2022, the bank raised rates by five times its estimate of 0.90%. 

Bond markets refuse to follow the Fed’s lead, pointing to an overall fall in rates by the end of the year. I prefer following heavyweight debt markets. To be more generous, I prefer to believe the Fed when it says it is data-dependent – and economic data may force its hand.

As mentioned above, the silver lining for a deteriorating economy is rapid action by the Fed, which would work to keep a downturn shallow and short-lived.

All in all, bad news for the US Dollar is good news for the world.