FX and Gold Outlook

While I believe that the recent gains of EUR/USD have been exaggerated and may lead to a near-term correction lower, I anticipate that the combination of factors influencing the currency pair will generally remain positive, enabling it to regain more strength over the next 6-12 months. On the positive side for EUR/USD, I expect continued repatriation flows from USD to EUR, driven by higher yields on European government bonds (EGB) and reduced sovereign credit risks. Additionally, stable global energy prices and the reopening of the Chinese economy are likely to help stabilize the external imbalances within the Eurozone.

However, on the negative side, the energy crisis in the Eurozone is expected to persist and have a significant impact on the region's outlook. The anticipated energy demand in the Eurozone before the next winter could result in fresh surges in gas and oil prices during the second half of 2023, potentially undermining the international competitiveness and external imbalances of the Eurozone. These factors may contribute to renewed weakness in EUR/USD throughout 2024.

The USD is expected to face downward pressure in the next three to six months due to multiple factors such as the Federal Reserve's tightening cycle reaching its peak, a potential US recession, and concerns surrounding the US debt ceiling. During this period, the USD is likely to underperform against safe-haven currencies like the JPY, CHF, EUR, and gold. However, it may maintain its strength relative to commodity and risk-correlated currencies, given the prevailing market uncertainty.

Looking ahead, the USD could reach its lowest point in early 2024 as financial conditions ease and the US economy experiences a recovery. Additionally, more favourable valuations of US assets may contribute to the USD's stabilization. On the other hand, the energy crisis could resurface, negatively impacting European G10 currencies and energy-importing countries like the JPY.

Despite Japan's inflation being above the BoJ target, limitations such as weak wage growth and a slowdown in global economic growth will hinder the central bank from making additional changes to its YCC policy in the next year. However, as the Federal Reserve's tightening cycle impacts the US economy and potentially triggers a recession, short-term yields in the US are expected to decrease and converge with short-term Japanese Government Bond (JGB) yields. This convergence is likely to result in a greater inversion of the US Treasury (UST) yield curve, causing the 2-10-year yield spread to narrow and consequently weakening the USD/JPY exchange rate.

Furthermore, there is a perceived risk that persistently higher interest rates in the US may create further challenges for regional banks in the country and reignite a safe-haven demand for the JPY.

Despite the recent strong performance of the GBP, it remains the weakest G10 currency based on my FX scorecard analysis. I believe that FX investors will continue to view the GBP as a valuable hedge against risk aversion and stagflation, and I’m sceptical that the currency will experience further recovery without the support of real UK interest rates and yields. Concerns arise regarding the negative impacts of the UK's economic slowdown, which could be exacerbated by the new fiscal austerity measures implemented by the Sunak government. Additionally, the deteriorating external imbalances of the UK and apprehensions that the Bank of England (BoE) is falling behind in addressing economic challenges may pose challenges for the GBP in the upcoming months. As a result, I maintain a cautious stance on the GBP for the next three to six months and anticipate a potential recovery only in late 2023.

Amidst concerns of potential challenges in global markets and the economy, the demand for the CHF is expected to persist. The recent shake-up in the Swiss banking sector has had minimal impact on the CHF's status as a safe-haven currency, while domestic fundamentals continue to be favourable. Notably, the Swiss National Bank (SNB) is considered one of the most hawkish central banks among the G10 countries, maintaining a firm hold on the CHF to prevent any unwarranted weakness.

Throughout this year, the CAD has demonstrated a stronger correlation with the USD rather than behaving like a typical commodity-based currency. Unless there is a significant decline in the global economic conditions, the CAD has the potential to perform positively. This is due to the possibility of the Bank of Canada (BoC) not standing out for an extended period with its conditional pause on interest rate hikes. Additionally, there is the likelihood of substantial short positions being unwound, which could further support the CAD.

As China reopens its economy, it is expected to have a positive impact on the AUD. However, the economic recovery in China is anticipated to be modest, primarily driven by consumption rather than investment. Consequently, this recovery will only provide a moderate boost to metallurgical coal and iron ore prices. The AUD will also benefit from elevated energy prices due to the conflict in Ukraine and increased demand for air travel and electricity in China.

In contrast, the RBA is projected to implement interest rate hikes at a slower pace compared to the Federal Reserve, Bank of Canada, and Reserve Bank of New Zealand (RBNZ). This is because Australia is not currently experiencing a wage-price spiral, which will limit the potential strength of the AUD.

The RBNZ, on the other hand, is pursuing an aggressive tightening cycle that will result in its Official Cash Rate (OCR) reaching the highest level among G10 countries. However, a recent cyclone and flood, coupled with the impact of a weaker USD and China's reopening, may lead to a recession in New Zealand, thus restraining the upside potential of the NZD. While China's reopening will boost agricultural exports from New Zealand, the firm energy prices will dampen its terms of trade. The return of Chinese tourists to New Zealand in 2023 will provide an additional boost to the country's economy.

US political risks could persist while Fed rate cuts draw near in 2024. This should boost the appeal of gold as a currency debasement and risk aversion hedge. We have revised up our XAU/USD forecasts for 2024 accordingly.

This content may have been written by a third party. ACY makes no representation or warranty and assumes no liability as to the accuracy or completeness of the information provided, nor any loss arising from any investment based on a recommendation, forecast or other information supplied by any third-party. This content is information only, and does not constitute financial, investment or other advice on which you can rely.