Recessions and currencies – Where should traders look for outperformance?
Financial markets behave differently when economic activity contracts, so you must adjust your strategy accordingly.
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FollowIncreased chatter about a global recession in 2023 might motivate traders who are fond of the forex market to reconsider what they want to focus on next year. Financial markets behave differently when economic activity contracts, so you must adjust your strategy accordingly.
Even during a downturn, however, trade opportunities arise, which is why you as a trader need to know what currencies have the potential to outperform. Of course, just because something has happened in the past, doesn’t mean that it will happen again next year, but you should be aware of such trends because they can help you better understand dynamics.
Alt-text: currencies to watch in a recession
Source: https://pixabay.com/illustrations/dollar-rate-world-economy-boom-1881265/
Flight to safety
One of the first changes to occur during a recession is that investors and traders become risk-averse. A flight to safety drives capital into less risky assets, and FX benefits from that, because this market is liquid.
“Cash is king” becomes the mantra, and since inflation drops during an economic contraction, the loss in purchasing power is smaller compared to the losses faced by other asset classes such as stocks and cryptocurrencies.
US Dollar
The first currency to consider is the US Dollar. As the global reserve currency, it is the primary funding tool not just for the USA, but also for foreign governments and corporations. During an economic expansion, the Dollar-denominated debt increases, while when a recession hits, refinancing or paying back the debt becomes challenging. This dynamic creates a strong bid for USD.
If you know a thing or two about forex, you are probably aware that the US Dollar was one of the leading performers this year and despite a temporary setback right now, the trend is less-likely to reverse sharply, given all the economic risks moving forward.
Swiss Franc
Another currency to watch during a recession is the Swiss Franc. As one of the leading financial hubs and a country that’s historically politically neutral, Switzerland has a long track record for safeguarding capital. Currency pairs that include CHF benefit from higher volumes when economic conditions deteriorate, and that is something that is likely to happen again in the future.
According to experts at easymarkets, this is a likely scenario, considering the Swiss National Bank (SNB) already abandoned the negative interest rates policy. At the same time, the central bank is committed to letting the currency appreciate, in order to counteract inflationary pressures.
Japanese Yen
Despite a poor performance in 2022, the Japanese Yen is another currency to consider. It weakened significantly against the US Dollar, mainly due to the divergence between FED and BoJ monetary policies.
The only central bank still keeping rates below 0% is the BoJ, fueling the rise of carry trade (buying currencies with positive rates and selling a currency with lower or negative rates). If an economic crisis starts, the interest rate advantage that other currencies are benefiting from right now will most likely vanish, as central banks will have to loosen monetary policy.
Capital will head the other way around and the Yen might benefit only by squeezing the shorts out of the market. On top of that, Japan remains a leading exporting nation, backed by strong productivity and fundamentals.
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