Forex market forecast (2022): What will drive markets in 2022?
The top forex markets right now
Forex is the most traded market in the world.It continues to grow. According to the Bank of England’s semi-annual FX turnover survey published on 2 July, average daily reported foreign exchange turnover reached $2.98bn in April 2021. This marked a 16% increase on the $2.58bn from October 2020 and a 20% increase on April 2020. While the survey might seem outdated, the figures are arguably still the most authoritative available for London.
The report revealed that EUR/USD remained the most traded currency pair in London, this was followed by GBP/USD and USD/JPY, which makes sense given that these are the most traded currencies globally. The report also highlighted a strong increase in trading in USD/CAD and AUD/USD.
What’s been moving the forex market and what to watch in 2022
The forex market is focused on two key factors right now: inflation and Covid-19. These factors are expected to be under the spotlight heading into 2022, driving central banks’ monetary policy decisions.
The reality is that the forex market is always looking towards inflation data for clues as to whether central banks will raise or cut interest rates. Higher interest rates boost a currency, while a cut to interest rates will often pull a currency lower. As a result, the consumer price index gauge of inflation is one of the most important data releases for the forex market.
So why is inflation so important right now? As economies re-opened after the pandemic lockdowns and economic activity ramped up, supply chain bottlenecks formed and energy prices surged. This resulted in consumer prices soaring to their highest levels in 30 years in major economies such as the US, the eurozone and the UK.
The latest inflation data from the US recorded the consumer price index (CPI) at 6.2% in October, a 30-year high. CPI inflation in the eurozone in November is expected at 4.9%, a three decade high. UK inflation hit 4.2%, a 10-year high.
Central banks had been adopting a similar stance, insisting that inflation was transitory. However, more recently there has been some divergence between them, and it’s been driving forex movements in the pairs.
At the end of November, the Federal Reserve (Fed) adopted a more hawkish stance. Fed chair Jerome Powell told the Senate Banking Committee that the word transitory could be retired from use with inflation. Powell also said that the tapering of bond purchases could be accelerated, which would mean interest rates could be hiked sooner. His comments lifted the US dollar.
Looking ahead in 2022, US dollar investors will likely be watching the Fed’s every move. While the Fed’s dot plot suggests that it will hike interest rates in the second half of 2022, the market believes a rise will come sooner. According to the CME FedWatch tool, the market is pricing in the first interest rate hike in May 2022. Should inflation continue to grow and the Fed turn more hawkish, the US dollar could rise in 2022.
The Bank of England (BoE) has also adopted a more hawkish stance in recent weeks. While the UK’s central bank didn’t raise interest rates in November, according to the CME BoEWatch tool, a rate hike is fully priced in at the February meeting.
Meanwhile, the European Central Bank (ECB) has been more dovish compared to the Fed and the BoE, insisting that the rise in inflation is transitory. The ECB forecast that inflation may fall back to 2% next year. One of the reasons for the ECB’s more dovish stance could be due to the fact that there is more slack in the eurozone labour market – unemployment is higher at 7.5% compared to the US or the UK, meaning less inflationary pressure from wage rises.
This divergence between the central banks has been responsible for the broad weakening that has been seen in EUR/USD and GBP/USD across 2021.
It is also worth noting that the Japanese yen has been the worst performing G10 currency across the year. The relatively risk-on trading environment for most of 2021 combined with a very dovish Bank of Japan has kept the Japanese yen pressurised.
There is a growing risk that the resurgence of Covid-19 may derail economic recovery. Omicron, the new coronavirus strain, which is highly mutated, appears to be spreading across the globe rapidly. So far, little is known about the strain. Initial findings appear to be encouraging, with US medical advisor Dr Fauci saying that symptoms from the new strain show less severity. Pfizer has also said that three doses of its vaccine will neutralise Omicron, which is certainly a step in the right direction.
As long as the Covid risk remains in check, performance in the forex markets next year is likely to be focused on central bank action and divergences.
Where do the experts see the forex markets heading in 2022?
In their forex forecast 2022, the major investment banks broadly agree that the US dollar can look forward to another strong year in 2022. But what about the other currencies? Let’s take a look at what analysts think and their forex market prediction 2022.
Analysts at HSBC see the USD strengthening further in the coming year, supported by the Federal Reserve progressing towards monetary policy normalisation and moderating global growth. They say:
HSBC analysts also consider that the euro is vulnerable against the stronger US dollar, given that no rate hike is expected by the ECB until late 2022, and even that seems optimistic. However, they also believe that some currencies will hold their own against the stronger greenback, such as the Australian dollar. They expect that the Reserve Bank of Australia could adopt a more hawkish stance, given the strength in recent data.
Analysts at ING also expect the US dollar to outperform its major peers, including the euro and the yen, noting:
With regards to the pound, ING analysts forecast that it will sit somewhere between the stronger US dollar and steady commodity currencies. Speaking of the Japanese yen, they remain bearish on the currency, while they see the Australian dollar benefitting from being undervalued and oversold, although they warned that this could be a risky trade.
Meanwhile, in their forex market outlook, analysts at the Canadian Imperial Bank of Commerce (CIBC) also predict US dollar strength in 2022 as the Fed begins to hike interest rates. In line with the other banks, they expect the euro and the yen to underperform. Interestingly, they also believe that the Canadian dollar could weaken in the coming year. They say:
While most agree that the US dollar could trend higher in 2022, some analysts see the greenback weakening in 2022 as supply chain bottlenecks ease and inflation cools. In his forex market analysis, Yohay Elam, currency analyst at FXStreet, says:
Note that analysts’ forecasts can be wrong. Forecasts shouldn’t be used as a substitute for your own research. Always conduct your own due diligence before investing. And never invest or trade money you cannot afford to lose.
How to predict the forex market?
It is impossible to predict exactly what the forex market will do. However, it is possible to use tools, such as fundamental or technical analysis to build an idea of how a currency pair might react to particular news or data, or how the pair could respond to certain price levels in the market.
Which forex pair is the most volatile?
AUD/JPY is considered to be one of the most volatile forex pairs on the market. More broadly speaking, commodities-backed currencies tend to be volatile.