The USD’s Modest Strength Looks Set to Persist in 2022

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Key Takeaways

• The US dollar advanced broadly in forex markets in 2021, we take a look at what’s ahead in 2022
• Monetary policy shifts are likely to keep the greenback’s dominance across the currency board

The USD Was Dominant in 2021 Boosted by the Fed

With 2022 right around the corner, the main player in the Forex market over the next twelve months is likely to be the US dollar. After it gained throughout most of 2021, the greenback is gearing up for a head start in January with major developments waiting to unfold.

First of all, the coming year will certainly be a year of transition. Over the previous twelve months, the US Federal Reserve was largely responsible for steering the US economy. Now that the market has more than recovered from its pandemic meltdown, the US central bank decided to change its approach.

In other words, it’s time for a monetary policy shift. In more detail, the Fed decided to shoot for the stars in March 2020 when Covid-19 hit and the wheels fell off the market. That’s when Jerome Powell, Fed Chairman, said the bank will be injecting as much as $120 billion into the US economy.

The US Central Bank to Unwind Its Monetary Support

About 19 months later, in November this year, Mr. Powell said the central bank was preparing to unwind the extraordinary monetary stimulus. A month later, in the Fed’s final meeting of 2021, there was an agreement between Fed officials to reverse the stimulus at $30 billion a month.

That means there will no Federal Reserve stimulus to support financial markets from April 2022 onwards. While this could translate to some stock market jitters, the US dollar might be in a favorable position.

Besides the Fed tapering, or reducing, its monetary support in 2022, the bank is also gearing up for its first post-pandemic interest rate hike. On that front, policymakers at the Fed have said they are prepared to raise interest rates not once but three times in 2022.

Presently, the ultra-loose monetary policy has led to easy money going into stocks, the housing market, and even cryptocurrency trading. All of this, however, has brought some unwanted economic consequences that have prompted the Fed to take its foot off the gas pedal.

Challenges and Opportunities for the US Dollar

For one, surging inflation has dented investor optimism. The US recorded a 39-year inflation peak with the November consumer price report. To this end, higher prices are expected to persist in 2022, although they might come down slightly as the Fed predicts.

Still, a few important developments are seen as factors that could boost the value of the US dollar. The most important one, we already mentioned: interest rate increases.

In practice, the three planned interest rate increases will make holding the dollar more attractive as it will give you more yield. This said, traders and investors may rotate their portfolios to hold a bigger portion of dollars.

Also, the US dollar is seen as a safe haven in the forex market. Often when uncertainties loom for the growth outlook, investors would pile into the greenback in efforts to preserve their wealth. On that front, market participants can quickly shift their focus on the dollar if anything extraordinary rattles the broad financial markets.

How the USD Could Perform in Forex in 2022

With all this in mind, expectations are that the US dollar will be impacted by the path of the Federal Reserve. The central bank’s potential actions in 2022 are likely to narrate the movement of the greenback against major peers. With this in mind, let’s take a look at how the dollar might perform across forex markets.

The EUR/USD, for example, has been showing signs of weakness in 2021 that can be transferred into next year. The pair reached an 18-month low late in November when the euro dropped to $1.1185. Further, more losses might be on the horizon for the European currency if the dollar gains traction in 2022.

It’s worth noting that the EUR/USD pair has erased about 7.5% of its value over the course of 2021. More precisely, the exchange rate slipped from 1.2240 in early January to a current market price of around 1.1300.

What About the British Pound and the Japanese Yen?

Also, the GBP/USD has been moderately pressured this year as the pair is about to finish December near 1.3350. In other words, about 2.2% lower than its opening price in January. This said, the British pound attempted to rebound in mid-2021 but efforts fell short and the UK currency dipped.

However, it has to be mentioned that the Bank of England moved towards its first interest rate hike since the pandemic arrived. In mid-December, the UK’s central bank decided to increase its main interest rate to 0.25% as the economy struggles with inflation at a 10-year high.

To this end, the GBP/USD might be in for some elevated swings as traders weigh the prospects for growth both in the US and the UK.

Still, even more, US dollar gains may be found in the USD/JPY. The Japanese yen, also considered a safe haven in forex, gave way to the dollar in 2021. More specifically, the USD/JPY rallied about 11% from January until the current market price of over 114.00. In November, it hit a five-year high as it peaked near 115.50.

The US Dollar’s Outlook for 2022 Remains Strong, HSBC Says

In that context, the outlook for growth in the US dollar remains strong as projections point to more gains ahead. In addition, a fresh take by HSBC economists presents an optimistic scenario for the valuation of the greenback. “Our view of a stronger dollar is one of a mild, slow, gradual appreciation,” an HSBC analyst said.