Global Economic Uncertainty Weighs on Currency Markets

As global economic uncertainty continues to weigh on currency markets, investors are closely watching the actions of central banks and governments for clues on how to navigate the potentially volatile financial landscape. With inflation figures remaining "way too high" and interest rates on the rise, the potential for a global recession looms on the horizon. Only time will tell how these economic factors will play out and what impact they will have on the value of currencies around the world.

The gains in the dollar were limited as a slew of data this week showed that the U.S. economy is slowing down in the face of high inflation and tight monetary policy. The dollar index and dollar index futures hovered around a 7-½ month low on Friday and were set to end the week largely flat. Markets are now pricing in the potential for a global recession this year, particularly if the Fed keeps hiking interest rates. Such a scenario, while negative for the dollar, is also likely to weigh on Asian currencies.

European Stocks

European stock markets are expected to open higher Friday, with investors attempting to maintain January’s positive tone amid concerns about slowing economic growth and tight monetary policy. European stocks have had a strong start to the year, with Germany’s DAX up over 7% year-to-date, helped by hopes that the expected economic slowdown in 2023 will not be as severe as previously feared.

ECB President Warns of High Inflation and Tight Monetary Policy

However, these gains remain tenuous, with European Central Bank President Christine Lagarde warning, at the World Economic Forum in Davos, Switzerland on Thursday, that inflation figures remained "way too high", reiterating the need for aggressive monetary policy decisions. Additionally, ECB officials were divided over whether to raise interest rates by 50 or 75 basis points in December, according to minutes from the ECB's policy meeting last month. The central bank eventually settled on hiking its deposit rate by 50 basis points, edging down slightly from three straight larger 75 basis-point increases rolled out earlier in 2022.

Retail Sales in the U.K.

This tightening has had an impact on German producer prices, which fell 0.4% on the month in December, an annual increase of 21.6%, but this was not as big a reduction as expected. The Bank of England also hiked by 50 basis points in December, having lifted interest rates by a combined 325 basis points in 2022 alone, to their highest since late 2008. This resulted in disappointing news for retailers over the festive period, as U.K. retail sales fell 1% on the month in December, an annual drop of 5.8% as the monetary tightening and the cost of living crisis weighed on discretionary spending.

Asian Currencies

Most Asian currencies fell on Friday and were set to close the week lower following hawkish comments from several Federal Reserve officials, as well as growing concerns over a potential recession this year. China-exposed currencies were the worst performers this week, even as data released earlier showed that the country’s economy was beginning to pick up after the lifting of most anti-COVID restrictions.

Lunar New Year Brings Hope for China's Economic Recovery

Despite rising COVID-19 cases and doubts over China's near-term economic prospects, traders are positioning for a strong boost to the economy from the week-long Lunar New Year holiday, which begins on January 23rd. The People's Bank of China has kept its benchmark loan prime rate at historic lows for a fifth straight month, straddling the line between shoring up economic growth and maintaining strength in the yuan.