What Happened

• Per the Bloomberg Dollar Spot Index, USD fell by 2.0% with growing faith the global economy will not recede.
• Equities around the world experienced a return to risk appetite, with the S&P 500 having its second-best start since the turn of the century.
• Euro strengthened by 3.0% with economic evidence of a recovery that avoided the worst-case energy scenarios previously feared.
• Mexican Peso reached its highest value since February 2020 after better-than-expected economic growth in Q4.
• Despite a surprisingly dovish Bank of Japan cooling down speculatory tightening, Yen rose by half a percent.

GreenShootsFX’s View

• A less hawkish Federal Reserve will exacerbate dollar losses unless data dictates otherwise.
• Central banks, such as the Bank of Canada, have already promised to hit the brakes on rate hikes.
• Escalation of the war in Ukraine and political turmoil in other regions could dampen some rosy expectations.
• U.K. protests may weigh on economic growth after the country avoided gloomy outlooks through end of 2022.
• A more accommodative financial environment is materializing, but there are still concerns that blur what is to come in a year full of optimism, thus far.

In Focus

• The euro has mounted a 13.0% comeback since falling below parity with USD.

• As relations with Russia only worsened after the invasion of Ukraine, Europe realized its economic health was at peril, with most energy outsourced.
• No Russian deliveries since September painted a bleak picture for the EU as winter made its way.
• Shockingly warm climate in autumn and steadfast preparedness helped Germany, where 52.0% of natural gas was imported from Russia pre-war.
• France and Italy have also managed to make headway, making up for lackluster growth in Germany.

In Depth

Safe haven dollar days seem to be behind us for now. Although there is still plenty of mixed feeling, risk aversion is fading enough to hurt the dollar.

It looks like the period for a disinflationary process has started. Ever since the mid-month releases of December inflationary measures, consumers have received good news while investors rejoiced. Price-growth in the form of Consumer Price Index (CPI) fell (-0.1%) as expected, while suppliers got an even bigger break with Producer Price Index (PPI) showing a monthly contraction of (-0.5%) instead of the (-0.1%) estimate to end the year.

A similar trend of downward price pressures seems to be taking shape around most regions of the globe, which is convincing central bank officials to reconsider changing the approach taken in 2022 to aggressively combat inflation. With the Federal Reserve seemingly on board to start slowing down the pace of interest-rate hikes, the dollar must get ready to be tested after already coming down significantly from record highs against its peers.

Just like we mentioned in our outlook for the year, 2023 is looking to be a story of two halves with much positivity in comparison to where things were in the summer. It is simple now to forget that 2022 also began with expectations of recovery and flourishing as a post-pandemic world opened back up. By now, we have faced the consequences of a sudden conflict, but also witnessed economic resilience and, potentially, a resurgence.

Indeed, not long ago, global fears of a recession seemed substantiated, with China struggling to abandon its strict zero-COVID policies while European countries searched desperately for alternatives to survive losing their biggest energy supplier. Furthermore, Russia’s geopolitical ambitions resulted in a loss of confidence after decades of cooperation in not just economic matters but those involving international security.

Globalized interconnectedness is facing a collection of its biggest challenges, including the long-term effects of COVID, such as a shortage in labor all over the world. Nevertheless, global markets came into this year hoping to see better dynamics at work aided by the end of a cycle of monetary tightening that started to fight record-high inflation affecting all nations and adding a toll on already weak growth.

In the U.S., Gross Domestic Product for Q4 grew 2.9% over the 2.6% pace expected, while Durable Goods Orders in December jumped 5.6%, double the estimated 2.5%. The data originally served as a boost to the buck, but quickly the tables turned.

The market interpretation was that the Federal Reserve has certainly made a dent in the economy, preventing it from expanding like before. In comparison, Q3 managed to expand by 3.2%.

While correct, the GDP figure being higher than expected (2.9% vs. 2.6%) also meant that the impact to the economy was not going to spark a slowdown that could turn recessionary. In all his statements, Fed Chairman Jerome Powell has credited a strong economy for allowing the Fed to hike interest rates to lower inflation.

At the time of writing, the Federal Reserve announced its decision to increase the Federal Funds Rate by 25 basis points to 4.75%. However, in his press conference, Powell explained that monetary policy would need to stay restrictive for some time, indicating that he does not foresee any pivot to cutting interest rates since the economy seems to be too strong for that to need to occur.

That seems also to forecast a second half of the year in which the Fed will leave things alone. Of course, it could hike one more time to reach 5.0%, which had been speculated to be their desirable terminal rate, perhaps even a little more, but we feel that officials already see an end in sight to exercising any more of their tools.

Letting the economy ride seems to be what most economists want the Fed to do with former U.S. Treasury Secretary Larry summers weighing in asking the Fed to stop signaling hikes in order not to scare economic activity and investment.

In Europe, growth still faces many challenges, but it is impressive how the Euro-zone is performing after chaos failed to materialize. For example, the GDP in Germany for the year finished at an average 1.8%, although it contracted unexpectedly in December.

Overall, stagnation in 2022 dragged all Euro-zone countries, but the doom envisioned has been countered by reviving stronger allegiances from a Western-front perspective. Also, price growth contracted in January.

Over on the other side of the pond, in the United Kingdom, the economy did not contract the (-0.5%) needed in the 3-month period through November necessary to guarantee a recessionary period. In fact, it managed to eke out a 0.1% lift.

While spirits are up on the Brexit front with some progress over the Northern Ireland protocol, a study has shown that leaving the EU cost £100.0 billion a year in output overall. It was calculated that U.K. GDP would have been 4.0% larger had it kept membership. We worry about strikes and turmoil now. Additionally, U.K. business confidence has been at its lowest since the financial crisis.