Global FX Views You Can Use: Goldilocks and the Wheel of Fortune

By: Mark McCormick, Mazen Issa, Ray Ng

January 23, 2023 - 3 minutes
Close up of a person's hands holding hundreds of dollars in American money.

Market themes: Lower tail risks, USD drawdowns, and lower yield curves

The market themes reflect an easing of 2022 tail risks and some Goldilocks optimism, capturing China reflation, a resilient Eurozone (EZ) economy, and peak inflation/Central Bank (CB) tightening. Still, the broad USD/FX volatility (vol) correction has been aggressive, overshooting a few of our models. The global economy is not out of the woods yet: growth is stabilizing, not accelerating, and China's Q1 reopening will likely be bumpy. Plus, global data surprises have turned lower just as earnings could throw a monkey wrench into sentiment.

Lower tail risks:

  • The USD drawdown to end 2022 sparked a debate about whether the downturn has begun. It feels like recession fatigue has set in, especially as tail risks around the global economy have eased considerably. China is reopening faster than expected, and the EZ is weathering the energy shock.
  • We see market themes transitioning again in 2023, underscoring the end of stagflation and a reversal of the terms of trade shock. Global synchronized tightening will also ebb, revealing a change in strategy toward currency valuations and a possible peak in real rates. A slowing US economy meets a lift in EZ and Chinese growth.

USD drawdowns:

  • Our FX overlay portfolio highlights the importance of three market themes in 2022: terms of trade, inflation and carry. The recent USD drawdown introduced a change in focus to valuation strategies. We expect more of that this year.
  • We see market themes transitioning again in 2023, underscoring the end of stagflation and a reversal of the terms of trade shock. Global synchronized tightening will also ebb, revealing a change in strategy toward currency valuations and a possible peak in real rates. A slowing US economy meets a lift in EZ and Chinese growth.

Lower yield curves:

  • The rub here is that we don’t see these global forces working against the USD in earnest until Q2. The global economy, while stabilizing, has shown little sign of acceleration across the models we track. Yield curves need to steepen, not flatten.
  • What’s more, the USD’s strongest correlations link to risk appetite, where a poor earnings season and still wobbly global growth environment could reverse the recent risk rally. China's reopening could be bumpy in Q1, increasing the risk of short-term setbacks. That said, our view is that we won’t see too much USD weakness until Q2. However, the risk to our view is that the USD weakness comes a little bit sooner, in Q1.

Opportunities

The USD still has room for Q1 consolidation, but it's time to sell the rallies. We believe that EURUSD should hold the 1.04/1.08 range for now, but we like holding EUR against NOK, SEK, GBP, CHH and CHF. The move in JPY is just getting started, but since we’ve already seen some appreciation over the last couple of months, entry levels are poor now. Any episodes of JPY weakness may provide a good opportunity to buy JPY against CNH, NZD, and USD; we like NZDCAD lower this month.

Factor performance, FX overlay, and forecast updates

Our Macro Ranking Scorecard Index (MRSI) FX model reveals some major theme changes, shifting performance to value from inflation and carry that dominated the past year. Further USD drawdowns will favor a rotation to value, but global growth needs a better footing. Still, TD Securities downgraded its USD profile, noting big upgrades to EUR and JPY, though downgrades to NOK, SEK on housing risks. Our forecasts show a deeper USD pullback in Q2 but risks skew toward seeing more USD weakness pulled forward into Q1.

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The views or opinions expressed herein represent the personal views of the writer and do not necessarily reflect the views of TD Securities or its affiliates.

This material is intended to provide commentary on the market for commodities discussed herein.

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Portrait of Mark McCormick

Mark McCormick
Director and Global Head of FX Strategy, TD Securities

Portrait of Mark McCormick

Mark McCormick
Director and Global Head of FX Strategy, TD Securities

Portrait of Mark McCormick

Mark McCormick
Director and Global Head of FX Strategy, TD Securities

Mark helps to manage the bank’s research efforts for the major foreign exchange markets, along with developing the analytical framework used for market analysis, forecasts and trade ideas across different asset classes. Before joining the bank, he worked as a Global Macro Strategist at Credit Agricole Corporate and Investment Bank in New York.

Portrait of Mazen Issa

Mazen Issa
Director and Senior FX Strategist, TD Securities

Portrait of Mazen Issa

Mazen Issa
Director and Senior FX Strategist, TD Securities

Portrait of Mazen Issa

Mazen Issa
Director and Senior FX Strategist, TD Securities

Mazen covers all aspects of G10 FX strategy. Previously, he was a Senior Macro Strategist based in Toronto where his coverage had a particular emphasis on Canada. Before joining TD Securities in 2010, Mazen spent several years at BCA Research in Montreal as part of the Global Fixed Income Strategy team. In that role, he was responsible for providing macro analysis and investment recommendations for the developed markets.

Portrait of Ray Ng

Ray Ng
FX Quant Strategist, TD Securities

Portrait of Ray Ng

Ray Ng
FX Quant Strategist, TD Securities

Portrait of Ray Ng

Ray Ng
FX Quant Strategist, TD Securities

Ray is a FX Quantitative Strategist spearheading the development of our systematic trading framework for the development of cross-asset strategies. Prior to joining TD, Ray worked at National Bank as a FO quant researcher/developer on a multi-asset quant desk. Ray has an MsC and a Ph.D. in computational condensed matter physics and completed his post-doc all at McMaster University.

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