The challenge for investors in this scenario is that, if policy makers continue to lift rates, that would keep the dollar rising, while Chris Beauchamp, chief market analyst at IG Group, says that if the global economy experiences a profound economic downturn next year, this may also cause investors to view the dollar as a safe haven, preserving its strength relative to other currencies.
He says the dollar has been relatively weaker recently as a result of market expectations that US rates may peak at a lower level than was previously expected. Beauchamp's view is that while there may be some dollar weakness in the first months of 2023, as the recession he expects to take hold next year comes to the fore, the dollar will become stronger as investors begin to prize it as a safe haven.
Diversification nation?
While many of the major developed market economies are battling a similar set of foes, McCaffrey believes 2023 could be a period where those economies on a divergent path could become more attractive.
He singled out Japan and wider Asian economies as likely to be on this divergent course next year.
McCaffrey said: “Japan has so far maintained looser policy settings, but any shift from its current yield curve control could lead to unintended consequences for the yen and potentially add another layer of risk to the already elevated levels of volatility in FX markets."
He believes China has also taken a different pathway in 2022, thanks to its zero-Covid policy and the reining in of its property market.
McCaffrey adds: "In the next 12 months, we expect policymakers to continue to focus on reviving the economy, investing in longer-term areas such as green technologies and infrastructure.
"Any loosening of Covid restrictions will cause consumption to pick up. The deglobalisation that has arisen from the pandemic and tensions with the US will take time to work its way through but is a theme that will grow.
“Emerging markets and Asian countries, with a weaker growth correlation with the US and Europe, present one way to increase diversification, while cash and quality investment grade securities offer defensive characteristics.”
But Rupert Thompson, chief economist at Kingswood, takes the view that Chinese equities have bounced a little in recent weeks as the market has begun to expect the country’s Covid policies to move towards the rest of the world’s, rather than diverge, as is presently the case.
Within this theme, sector diversification plays a part
David Jane, multi-asset investor at Premier Miton, says one outcome of the higher-interest rate environment is that sectors such as technology and cryptocurrency are falling, which will reduce some individuals wealth and also cause unemployment to rise, both scenarios which would be expected to cause inflation to fall in 2023.
