Main asset classes Currencies 42 | 43 Eurozone-wide debt issuance discussions to stem a CNY weakness should persist potential weakening of the EUR, thereby requiring a The Asia FX complex is likely to remain weak in the Monetary policy, growth dynamic management of EUR positions. first part of 2023 given the resilient USD trend. Some divergence across the region can be expected, EM hampered by lower carry, growth risks depending on the various economies’ dependence In 2022, EM currencies held up well against most on manufacturing exports, which are likely to be likely to drive FX developed market (DM) currencies. However, the more impacted by the slowdown in global demand outlook for EM currencies versus the USD continues than commodities and services. This is one key to be challenging despite already cheap valuations. reason why the CNY is likely to weaken. The other In early 2023, the ongoing tightening of global is that imports are likely to accelerate as expansion- financial conditions and a hawkish Fed should ary fiscal and monetary policy starts to feed through continue to support the USD. In the second part of into the real economy in the months to come. We expect the USD to remain overvalued in 2023. A turning point in the USD’s 2023, the USD could lose some of its strength. Further out, the relaxation of COVID-19 restrictions strength remains largely conditional on a shift in US monetary policy and That said, recessionary risks could still cloud the is likely to reignite tourism outflows and bring the environment for EM currencies even though eco- current account surplus down from 2% of gross improving global growth prospects. The significant undervaluation of the JPY nomic activity in EM is expected to hold up some- domestic product currently toward the 0.5% pre- should reverse but will ultimately require the Bank of Japan (BoJ) to abandon what better than in the USA. Some EM central COVID level. With the CNY still 3%-4% above banks are expected to loosen monetary policy ahead pre-COVID highs in trade-weighted terms, we its yield curve control policy. Emerging market (EM) currencies should of the Fed. This could further diminish the carry expect Chinese authorities to be more than comfort- remain soft in general. Finally, active foreign exchange (FX) management will buffer and also the risk-adjusted carry in light of able with a meaningful CNY depreciation. Within the high volatility. A challenging environment for com- region, the IDR should prove more resilient in 2023, be of the essence in a world of heightened volatility and rapid shifts in the modity prices would be favorable for the inflation pic- due to its trade surplus and attractive carry against forces driving FX. ture in EM, but would lead to a further deterioration the USD, which is among the highest in the region. in the terms of trade, which were a key supportive factor for EM FX in the first half of 2022. Within the EM FX space, we are especially cautious on currencies with a larger exposure to DM recession The USD Index (DXY) is on track for one of its best tion to stem the depreciation of the currency. For risks, as well as geopolitical tensions and the annual performances in decades in 2022. We think the first time since 2014, Japan has witnessed slowdown in China. In this context, Eastern this unusual strength, which has created a substan- mounting inflationary pressures, and the JPY’s European currencies such as the PLN look particu- tial overvaluation of the DXY, is justified. The US sharp depreciation in 2022 might add to imported larly vulnerable given the country’s strong trade ties economy has been strong, resulting in a tight labor price inflation. The eventual abandoning of the YCC with the Eurozone countries and geographical market. With underlying inflation substantially more policy by the BoJ in 2023 is a key risk. As the Fed proximity to the Ukraine war. elevated than the US Federal Reserve’s inflation will likely pivot to a less hawkish stance sometime i target, the Fed initiated the fastest policy tightening n 2023, we think this combination would mark an in decades. This generated a major source of USD end to the sharp JPY depreciation and a potential support through increased carry attractiveness. significant reversal of our estimated 40% under- Furthermore, the USD’s safe-haven characteristics valuation in JPY vis à vis the USD. proved attractive at a time of deteriorating risk sentiment globally. Both these factors will likely Active and flexible FX strategy remain in place going into 2023, and we expect the FX volatility surged in 2022, virtually doubling from USD to remain largely overvalued throughout 2023. the level at the beginning of the year. While we do A turning point in the USD might come later in 2023. not anticipate a similar gain in volatility in 2023, we A dovish Fed pivot together with an improving global expect it will remain historically elevated. The economic outlook would be needed for the USD to uncertain pace of the global growth slowdown (or give back its gains. recession in some countries), combined with the volatile inflation normalization and persistent geopo- JPY depreciation likely to turn in time litical uncertainties, is setting the scene for another Among G10 currencies, the JPY has been most year of potentially large market swings. For this impacted by the ever increasing rates differentials in reason, we believe that active and flexible FX 2022. The Bank of Japan (BoJ) is expected to hold management is a crucial strategy for investors. For on to its yield curve control (YCC) policy until at least example, resurfacing peripheral risks in the March 2023. As such, pressure on the JPY will Eurozone could force the European Central Bank likely remain substantial despite recent FX interven- to intervene, or result in a further push for renewed