2023 looks set to see "King Dollar" deposed from the throne. It has been an extremely strong 18-month spell for the greenback, but it's likely to end as the U.S. Federal Reserve nears the end of its hiking cycle and the U.S. economy enters a potential recession.
I indicated in my December 21 column that this makes a strong case for holding unhedged positions in Japanese stocks, since the Japanese yen has suffered some of the greatest weakness against the U.S. dollar. But the same trend of dollar weakening will play out in other markets, too. Many Asian equity markets will therefore provide a passive benefit for U.S. investors in 2023 if the local currency advances against the dollar. Any gains then translated back into the weaker greenback look greater after that transaction.
Top that off with a likely return to emerging-market risk and allocations among global investors, and Asian EM plays look strong. While I hesitate to trade FX itself, unhedged exchange-traded funds offering access to any of the currencies below should pay off.
It seems that Nomura is on the same page. I've just got an interesting report from their global FX strategists outlining their top-5 currency plays right now. And 4 of the top 5 are in Asia, making the most of rallying currencies in the region.
It has been the easing in U.S. inflation that prompted a turnaround in the U.S. dollar trendline. After peaking at 9.1% in June, the inflation rate lurched 500 basis points lower in October. As of the latest figures available, for November, it stands at 7.1%, with apparent further room to fall. Inflation is still high enough for Fed officials to keep suggesting they haven't done enough yet. But the end of the rate rises is surely in sight, likely this year.
The U.S. dollar index (DXY) shot up from 90.0 in mid-May 2021 to 113.3 in mid-October 2022, a mammoth 25.9% rise. Since the inflation figures eased, it's seen a sudden fall, down a sharp 8.6% to 103.6 on December 26, although it has arrested that trend in the last week and now stands at 105.3.
Nomura's conviction on its currency plays has strengthened since the last Fed meeting on December 14. The investment bank now predicts a final 25 basis point increase in March 2023. That leads it to a more-significant short bias on the U.S. dollar, globally.
The reopening of China that will be enabled by the end of the zero-Covid policy, while leading to a massive and painful Covid outbreak right now, should ultimately cause capital inflows into emerging markets, and Asia.
As a result they make these calls.
1. Short U.S. Dollar/Long Chinese Yuan
This call has risen to a conviction rate of "4" out of 5, up from 3, with the Japanese bank setting a target rate of C¥6.60 to the U.S. dollar by the end of February. The yuan currently stands at C¥6.86, so that would represent a short-term 3.8% advance.
A faster pace of reopening in China could lead to greater yuan gains. China is scrapping most of its travel rules, including mandatory quarantine for returnees, on January 8, when the Beijing administration may also give further details on how it aims to revitalize the economy. Any better prospects for the Chinese economy may also encourage overseas investors to revisit China, leading to inflows that would further support the currency.
2. Short U.S. Dollar/Long Japanese Yen
Much the same logic applies to the yen, which Nomura foresees strengthening to a target ¥127 by mid-February. It's now at ¥134.30. So that's a 5.4% short-term gain in the Japanese currency.
The yen went as high as ¥150 to the U.S. dollar in October, its weakest level since 1990 and the end of Japan's asset bubble. But the breaking of inflation's feverish pace of increase in the United States caused a sudden correction, with sudden spells of yen strength in both November and December.
It's also worth watching the central Bank of Japan, which will see current BOJ Governor Haruhiko Kuroda step down in April. The BOJ tweaked its monetary policy last month, although I read that move as a concession to yen weakness, allowing the bank to keep rates lower for longer. There's always the potential for a shift in policy, with any suggestion of monetary tightening only adding wind to the yen's sails.
3. Long Euro/U.S. Dollar
The only non-Asian play of the bunch. The mild winter so far in Europe isn't great for Alpine ski resorts but has helped ensure the worst fears over sky-high gas prices and electricity shortages didn't come to pass. Gas storage therefore remains higher than usual, while Germany has been switching to coal production for power as far as possible, to reduce its reliance on Russia.
While recession is also on the cards in Europe, governments have been armoring up to provide fiscal firepower, certainly in contrast to the United States. "Altogether glimmers of hope down the line are why we believe being long EUR may be the trade in 2023, in contrast with last year," the Nomura crew assert.
They also have a 4 out of 5 conviction call, setting a euro exchange target of US$1.10 by the end of January. Selling a euro will currently fetch you US$1.06.
4. Long Thai Baht vs. Short U.S. Dollar (66.6%) and Euro (33.3%)
This is a maximum 5 out of 5 conviction call! But Nomura is switching the weighting from an even 50% split to a two-thirds short weighting on the dollar. The Japanese bank was already bullish on the Thai currency, and expects a 10% total gain on the trade by the end of February.
Thailand is the chief beneficiary of the return of Chinese travel, with Chinese visitors accounting for 27.6% of total tourists in Thailand in pre-Covid 2019. Thailand is also the economy that gets the heaviest weighting from the tourism sector, accounting for 17.9% of the entire economy in 2019, according to Statista.
Trip.com (TCOM) reports that Bangkok was one of the top destinations booked as soon as quarantine was scrapped for returning Chinese travelers. Nomura expects 28 million tourist arrivals in 2024, running ahead of already-raised government forecasts of 25 million travelers.
As a manufacturing base, Thailand could suffer from slowing global growth and demand. Those negative influences could be offset, though, by cheaper freight costs and lower costs for Thailand's imported energy.
5. Long Singapore Dollar/Philippines Peso
The Sing dollar is managed against a basket of currencies, and the Monetary Authority of Singapore uses unorthodox methods to execute its monetary policy via the currency. But the Singapore central bank has been tightening, adjusting the "slope" of the exchange rate accordingly.
Inflation in the Lion City is likely to rise to 6.2% in Q1. So the tightening trend will likely continue this year. The Philippines peso is, by contrast, facing depreciation pressure that the central bank is unlikely to resist.
This trade is only a 3 out of 5 on the conviction scale, so it's the weakest call Nomura is making. But it anticipates gains of 600 basis points on the SNG/PHP call by the end of February.