As the most traded and liquid financial market in the world, the Forex market is the main focus of the markets with analysts, institutional investors, and retail traders all attempting to determine the major fx trends that may shape the markets in 2022.
In 2021, the forex market was fueled by two leading factors – COVID-19 and inflation, and these factors will definitely continue to define the FX market’s behavior in 2022, with investors watching central bank’s monetary decisions closely.
Why does inflation matter to FX markets?
Exchange rates are typically an extension of monetary policy; central banks decide whether they want their respective currencies’ growth to accelerate or diminish, usually in an effort to stabilize them.
Higher interest rates tend to boost currencies, while lower inflation rates cause them to depreciate. In 2020, the COVID-19 pandemic slowed down global supply chains and created worldwide product shortages, which in turn led to consumer prices soaring as economies started reopening in 2021.
For a while, central banks have insisted that inflation was transitory; however more recently, the Federal Reserve (Fed) developed a more hawkish stance on the matter, with Fed chair Jerome Powell telling the Senate Banking Committee that the word ‘transitory’ should be ‘retired’ when referring to inflation.
Many industry experts, including our inhouse fundamental analyst Marshall Gittler, do not agree with this stance, “Most of the recent increase in inflation is due to the impact of the pandemic. While it may take longer than expected for inflation to get back to more normal levels (hence the idea of retiring “transitory”), I still expect the global economy to gradually adjust to the “new normal” and for inflation to decline next year on its own accord.”
Can the Dollar Continue to Rally?
It’s difficult to predict where the USD is headed in the long-term, as the currency has moved ‘sideways’ in the past few years. At the same time, the Fed’s recent actions and Powell’s comments have lifted the currency, and should inflation continue to grow then USD could rise in 2022.
USD traders and investors will pay close attention to the Fed’s actions in 2022; at this point, the Fed has a more hawkish stance. On the other hand, the European Central Bank (ECB) has had a more dovish stance in comparison to both the Fed and the BoE. One of the reasons for the ECB’s position on inflation, could be the fact that the Eurozone’s unemployment is higher to that of the U.S. which means there is less inflationary pressure from wage increases. This rift between the main central banks has caused the weakening of the EUR/USD and GBP/USD pairs over the past year.
Will Inflation Spark a Rally for Commodity Currencies?
With inflation set to remain rampant in 2022, oil prices are expected to continue to rally and this could impact commodity currencies such as AUD, NZD and CAD. However, it also likely creates a hawkish case for the Fed which means central banks could move in lockstep over their rate-hike cycles. It therefore becomes a question of which Central Bank will have more fire power and how they would go about forging their monetary path in a way that strengthens their respective currencies more over their major peers.
And under this scenario, it could simply come down to interest rate differentials and their perceived future path as to how well the respective currencies would then perform. It’s worth noting that the Canadian dollar may have an edge over its commodity FX peers as the BOC is perceived as the most hawkish of the major central banks.
How Can Traders Anticipate Upcoming Trends in The FX Markets?
The beginning of the COVID-19 pandemic made it very evident that it’s not possible to foresee how any financial market will perform in the future. In early 2020, the stock market crashed and signaled the beginning of a recession. But with the help of fundamental and technical analysis, it’s possible for traders and investors to interpret how certain price levels may respond to certain geopolitical events, monetary policy releases, and economic events.
To read more about the major events that may drive the markets in 2022 and what kind of impact they may have on the forex markets, you can read our Economic Market Outlook for 2022, prepared by Head of Investment Research at BDSwiss, Marshall Gittler. In this extensive report our veteran market analyst shares his expert insights on the major macroeconomic trends and market scenarios to expect in the upcoming year.