5 key factors that could impact exchange rates in 2023
By the OFX team | 5 November 2022 | 5 minute read
Global currencies continue to be buffeted by headwinds, both political and economical. Our experts spell out what that could mean for you in 2023.
1. War in Ukraine
Russian President Vladimir Putin shows no sign of backing down from the disastrous war in Ukraine. On top of the 300,000 new conscripts, Putin has been mobilizing Russian industry and the economy for his “special military operation” – effectively sending the message the country was digging in for a protracted war.3 He has raised the specter of nuclear action by asserting Ukraine was preparing a “dirty bomb”4 and on November 1 suspended participation in the UN-Brokered Black Sea Grain Initiative to allow safe passage of Ukrainian grain exports.
Food and energy costs will likely remain elevated, adding upward pressure to global inflation, especially in the Eurozone
says Jake Trask, Senior Corporate Client Manager at OFX. “If Russia blocks the export of grain from Ukraine or completely cuts off energy supply altogether, food and energy could spike higher.” That will place further downward pressure on the euro and the pound.
2. European Energy Crisis
The energy crisis is expected to deepen going into 2023, with the Eurozone particularly vulnerable.
In its latest World Energy Outlook, the International Energy Agency warns “the upcoming Northern Hemisphere winter promises to be a perilous moment and a testing time for EU solidarity – and the winter of 2023-24 could be even tougher.”5
Russia’s gas outflows to Europe have fallen by 80% since the war and although gas reserves have been topped up, all eyes will be on the weather. “A cold snap could see these stockpiles rapidly depleted,” says Jake Trask, Senior Corporate Client Manager at OFX.
Rationing of energy supplies would cripple economic output and see the euro under even more pressure, driving investors to the safety of the US dollar.
3. Diverging economies and monetary policy
Some economies, like the Eurozone, Canada and UK, are clearly facing headwinds that will dampen economic growth. By contrast, the US continues to power along, with the latest quarterly figures showing 0.6% growth after two consecutive quarters of contraction.6 Despite hits to private sector demand and the housing market, the US job market remains strong and consumer spending also increased.7 Inflation continues to rise albeit at a slower pace8, prompting the Federal Reserve to raise interest rates by another 0.75% last week.
Despite rampant high inflation, central banks in struggling economies will need to be wary of raising interest rates too sharply in the face of such challenging economic conditions. We have already seen the Bank of Canada and the Reserve Bank of Australia slow the pace of rates in the past month. The higher the interest rate relative to another country, the greater yield advantage the currency has, driving investor demand.
“The expectation of further aggressive rate hikes from the US Federal Reserve means the US dollar is well positioned to extend its gains even further against currencies such as the pound and the euro as we head into 2023,” says Trask.
4. China’s Covid zero policy
Xi Jinping cemented his iron grip on power at the 20th National Congress of the Communist Party of China in October, becoming the only leader to rule for a third five-year term since Mao Zedong.9 Whatever scant opposition President Xi’s policies previously faced will now be diminished, and OFX’s Jake Trask says that will have global consequences.
“As Xi Jinping was re-elected for another 5 year term, his firm grip on power will likely mean that the country’s zero Covid policy will remain in place going into 2023,” Trask says.
This in turn could lead to further lockdowns and knock-on effects to global supply chains and the cost of goods.
Daily COVID infections in China hit a six-month high recently and government officials reiterated that they will continue to clamp down on transmission with a policy of “dynamic clearing” including lockdowns, quarantining and rigorous testing.10
The country is keen to avoid the kind of lockdown that shut Shanghai down for two months this year, and is looking to become more precision targeted in how those lockdowns are enforced. China also began rolling out what is believed to be the world’s first inhalable COVID vaccine.11
But with little natural immunity in China, the country is still vulnerable to widespread breakouts, leaving a cloud hanging over the world’s factory.
At a time when inflation continues to soar globally, any hit to supply chains will have ripple effects and could make the path to stabilizing the global economy even more difficult.
5. US Midterm elections
Financial markets hate uncertainty, so unpredictability in US politics could be a key factor to watch in 2023. The US midterm elections could be a sign of what’s to come next year.
As American voters go to the polls on Tuesday November 8, they do so as a very divided nation. According to a New York Times/Siena College poll, nearly three-quarters of Americans believe democracy is in peril, with most identifying the opposing party as the major threat.1
With Republicans predicted to win the House of Representatives and likely the Senate, that does not bode well for a collaborative relationship between the US Congress and President Biden’s administration.
Congress has to approve budgets every year and a Republican sweep could mean signature policy from the Biden administration may face funding issues. The increasingly rancorous political relationship between Democrats and Republicans has meant that in 43 out of the past 46 years there has been a failure to approve full-year appropriations in time for the October 1 start of a fiscal year. In 2018, that led to a 35 day impasse and partial government shutdown, including temporarily laying-off government employees.2 The outcome of the midterms could determine if this pattern repeats in 2023.
A huge turnout for Republicans, particularly those Donald Trump has championed, would also embolden Trump’s bid for re-election. Although that wouldn’t take place until 2024, his presence on the national stage would likely be destabilizing for the Biden administration and throw into doubt whether key domestic policies would survive into a Trump presidency. Trump would also have a very different approach to foreign policy and has already advocated for negotiations to end the war in Ukraine. Conflicting views on US foreign policy coming from Trump could also have geopolitical ramifications.