Macroscope | Why 2023 may be a good year for renminbi bulls
- The US Federal Reserve will continue to raise interest rates, even if it crimps economic activity, while China is easing some Covid-19 measures
- The prospect of the US economy slowing somewhat, while Chinese economic activity picks up, lends itself to a weaker greenback versus the yuan
Currency market trends don’t tend to end abruptly. The US dollar may still have room to strengthen versus currencies such as the Chinese yuan. But the tide could be turning and, in 2023, renminbi bulls may come up smiling.
More than 20 years ago, Stephen Li Jen and Fatih Yilmaz, both now of London-based Eurizon SLJ Capital, created the concept of the Dollar Smile framework. On one side of the Smile is US dollar strength derived from fear, in recognition that the greenback, as the global economy’s key reserve currency, is seen as an international safe haven in uncertain times.
On the other side of the Smile is US dollar strength predicated on investor greed. When the United States economy is outstripping other major economies, and expectations of higher US yields dominate investor thinking, the greenback strengthens on the foreign exchanges.
A semicircular arc that joins those two points and forms the Smile reflects how markets react when either the fear factor dissipates or investors start perceiving prospects for the US economy to be dimmer than for other economies.
In both cases, investors react by moving out of the greenback, pushing it weaker until the US dollar finally gets oversold at the base of the Smile and starts to rebound.
In reality, no currency market participant can ever know with absolute certainty when it is the top, or the bottom, in the US dollar. That can only be certain in hindsight.
