A Look at 2022 Currency Volatility and Expectations for 2023

February 09, 2023 at 14:07 PM EST

Foreign exchange is often described as a volatile market, but currency volatility 2022 was higher than normal. The reasons for this are fairly intuitive, particularly when considering the dramatic impacts that both Covid-19 and a European war have had on the global economy.

The post-Covid Global growth slowed from 6% in 2021 to 3.2% in 2022 – this decline is set to continue into 2023. Furthermore, global inflation rose from 4.7% in 2021 to 8.8% in 2022. Given that GDP’s growth declined yet inflation rose, we can conclude that the inflation wasn’t driven by demand outpacing supply, but rather supply costs rising. In fact, post-Covid supply chains have been plagued by disruptions, not to mention the rise in raw material prices and energy.

The impact that this has had on currency is significant. Geopolitics has made some currencies extremely high-risk, such as the Russian Ruble, whilst rampant inflation in Turkey has caused the debasing of the Lira. Currency volatility 2022 was also rife because interest rates went from being totally unused and minimal to suddenly the core way to combat inflation.

The impact of inflation on exchange rates is huge, but in part because of the response it requires. The Fed raised rates from close to 0% to 4.5% in 2022 – which had a huge shock to the monetary system. This influenced how attractive the dollar was, because interest payments for savings were not just high, but higher than in most European countries.

How exchange rate works

The currency exchange rate that we see on the news is essentially the result of supply and demand. There is no objective or centralized way to determine the price of a currency, rather, it’s a result of natural market forces. If the Egyptian economy is declining and investors turn away from it, the increase in selling (supply) of the Egyptian pound, and decreasing demand for it, will result in it becoming cheaper relative to another currency that hasn’t experienced the same changes in supply/demand.

Major currency pairings

Below are a handful of the most common currency pairings. Here is how they fared in 2022, and what they may look like in 2023.

GBPUSD

At the beginning of 2022, £1 could get you roughly $1.36. By September, the pound only cost $1.08, though there was some recovery back up to $1.21 towards the end of the year.

The narrative for this currency pairing has been Brexit and the downfall of the British economy. Whilst this is true, and certainly is the reason behind the September crash (a British mini-budget farce), the truth is that just the strengthening of the USD is just as much the driving force of this.

In 2022, the USD appreciated over 12% (aggregated across all currencies) – a two-decade high. The major reason for this is that the Fed drove up interest rates quickly and forcefully to combat inflation. Whilst the Bank of England also increased rates, they were always later than the Fed’s, and slightly tamer.

The other reason for the GBPUSD has been geopolitics and economics. Namely, compared to the UK, the US has come out of the Russian war on Ukraine fairly well. Their US-led NATO positioning has strengthened, energy exports rose (plus being more energy independent than the UK), US arms sales rose by 50%, and GDP rose by 9.2% in 2022.

GBPUSD predictions 2023

The pound to dollar predictions 2023 are fairly on track with what happened in 2022. JP Morgan argues the US dollar will continue to rise, with GBPUSD set to drop to 1.14 in March and 1.08 in December – edging closer to parity. In a high-inflation, unstable global market, the global reserve currency intuitively does well. Post-Brexit adjustments are set to continue being challenging.

EURUSD

The story of 2022 for the Euro was very, very similar to the British Pound. Whilst their post-Brexit adjustments haven’t been quite so challenging, their restriction over raising interest rates made things more difficult. Because of the precarious debt positions of many Mediterranean countries like Greece and Italy, if the European Central Bank raised rates too quickly, they could cause those countries to default as they fail to meet repayments. Still, at under 3%, the EU base rate is not high enough to adequately combat inflation, and this made the Euro unappealing.

By the end of 2022, the Euro weakened by almost 17% against the dollar, and actually plunged below parity in July – the first time that happened in two decades. Plagued by a European war with its subsequent energy crisis, and tighter central bank restrictions, the Euro really struggled in 2022.

EURUSD predictions 2023

The Fed plans to march on with further increases in rates, followed by a long pause. If the EU does continue to raise rates, it will not be by much. For this reason, along with continued supply chain issues and an energy crisis that is set to last for all of 2023, it’s difficult to see euro to dollar predictions 2023 being anything other than close to parity in 2023.

How to deal with volatility as a business or individual

This may all be good or bad news depending on which side of the pond you sit – or whether you’re a net exporter or importer. The first thing to do, be it a business or individual, is to read the news enough to understand that there will be upcoming volatility.

However, whilst we can sometimes vaguely gauge future volatility, we cannot accurately predict the direction of these price changes. This is because the market is forward-looking, meaning that the expectation of the aforementioned volatility, interest rate changes, and GDP news is already priced into the market. Everything mentioned above in the 2023 predictions is common knowledge, and therefore already reflected in the current prices. In other words, there is no possible way to get ahead of the curve given the sheer number of market participants (and the intelligence of algorithms).

So, the lesson here is to concede that we cannot accurately predict currency swings, and that trying to do so would be gambling.

Cutting costs and maximizing exchange rate

With that in mind, the first step is to simply look at ways to minimize the cost of exchanging money. Whilst the Euro may cost 3% more next week than it does this week, that is hardly even the actual current costs of exchanging your money. But it doesn’t have to be.

Generally, it is high street banks that are so costly when moving money overseas. A simple international transfer can set you back both a flat fee/wire fee (i.e. $30), along with an exchange rate that isn’t actually the real rate – it’s got a 3-5% margin factored in for profit.

So, it’s important to get the basics right and avoid this. There are many inexpensive methods and alternatives to banks, such as money transfer companies. The best currency exchange rate will charge 0-1% margins and zero flat fees – or vice versa. Plus, you will have the benefit of faster, more accessible transfers using more modern apps.

So, instead of worrying about politics, the best USD to pound rate is the one you can get at the cheapest provider – control what you can control.

Mitigating fluctuations by locking in your future exchange rate

Finding the cheapest money transfer methods is a great start, but there is a practical way to nullify future currency volatility, too. This is known as hedging. In short, a currency hedge, such as a forward contract, is to lock in the price of a future transfer right now. So, you agree that in 3 months’ time, you will buy 5,000 Euros using USD, but you lock in today’s exchange rate (plus a small fee). This means that if the price changes wildly, it doesn’t affect you as you have a contracted transfer at a given price.

This is perfect for businesses. Many firms know that they will have repeated future payments, such as quarterly purchases from overseas suppliers. Of course, the price could swing the opposite way that would have been beneficial to you. If you want to have the option of backing out of the contract and using the future exchange rate, there is the choice of an Options contract.

Final word

2023 looks like another year in which the dollar strengthens. Whilst we cannot know for sure, it is difficult to put forward the case for a decline in the USD given its strengthened geopolitical positioning, along with high(er) Fed rates than elsewhere and a strong labor market.

But, as an individual or business, we cannot make decisions that are grounded in FX market speculation. Instead, focus on the things we can control, such as finding the cheapest currency exchange along with locking in hedging contracts to nullify currency swings. Because, whilst we do not know which currencies will strengthen and which will decline, we can be reasonably confident in currency volatility 2023 being similar to that of 2022.

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