Although the global tightening cycle is approaching its final phase, monetary policy remains one of the primary drivers of FX market price action. As such, in this month’s forecast document, we take a look at what took place in the latest round of central bank meetings and how it informs our outlook for future policy decisions. Our expectation is that interest rate volatility is likely to grind lower in the coming months with more central banks opting to observe the transmission of previous hikes. The impact this will have on lowering the right hand tail of the rates distribution, and the limited signs of an impending recession also weighing on the left hand tail, is likely to result in most major bond yields trading within recent ranges. With rate differentials still a primary driver of FX markets, this should lead to most major currency pairs trading within recent ranges too, although some differentiation within currency groups is likely based upon inflation dynamics, growth prospects, and financial stability concerns. In this environment, with the US economy still ticking along at a steady rate of growth, we expect the dollar to remain supported above its year-to-date lows. Towards the end of 2023, however, as the transmission of monetary tightening becomes more evident in the economic data, we expect volatility to pick up as rate cuts come back into view as the US economic outperformance story runs out of steam. At present, we expect only a mild US recession towards the end of the year, leading the Fed to begin its easing cycle in 2024. But as has been the case for much of the past year, risks around this outlook remain elevated, largely centred on the persistence of core inflation pressures and monetary policy induced recessions.
You can read our July 2023 FX Forecasts report here:
Simon Harvey, Head of FX Analysis
Jay Zhao-Murray, FX Market Analyst
María Marcos, FX Market Analyst
Nick Rees, FX Market Analyst