The fate of any currency depends on the rates. If the world economy is doing well, the markets are ruled by greed, and they bring money where the cost of borrowing is higher. If things are bad, then capital must be preserved. Safe haven currencies whose central banks set low interest rates are popular. Knowing this mechanism, it is easy to answer the question, why was the U.S. dollar appreciating in 2022? Investors were counting on a recovery from the pandemic to benefit the global economy, and instead of raising the federal funds rate by 75-100 bps as it projected at the end of 2021, the Federal Reserve raised it by 425 bps!
The greenback enters 2023 with mixed feelings. The Fed plans to raise the cost of borrowing to 5.25% and keep it there for a very long time. The markets are confident that rates will not get to that point. At most, up to 5%. After that, they will begin to fall in the second half of the year. Who turns out to be right will depend on inflation and the state of the U.S. economy. The Fed has been taking bilateral risks into account for some time now; it doesn't want to drive the economy into a recession. If the central bank's forecast turns out to be correct, the U.S. dollar will fight hard. If the market hits ten, it will seriously weaken. The process may not follow a straight road, but a winding one.
FOMC federal funds rate projections
So, ING believes that investors are too optimistic. They are counting on a soft landing, which is not going to happen. The state of the U.S. economy will worsen, which will increase the demand for the dollar as a safe haven asset. As a result, EURUSD will fall during the first three months of 2023. Wells Fargo holds similar views. It believes the Fed will not only raise the rate above market expectations but also above its own targets, which will strengthen the greenback.
In contrast, Double Line Capital predicts that even if the Fed raises the rate to 5%, it will be forced to cut it almost at the next meeting, as the U.S. economy will quickly weaken. Cross Border Capital believes that the USD index might correct by 10-15% over the next year as the Fed pumped liquidity into the weak debt markets.
Thus, the main scenario is either the dollar grows during the first 3-4 months of the year, followed by a decline, or a continuous downtrend in the USD index.
Of course, there are always two monetary units in any currency pair, so we have to consider how the euro will move. Judging by the fact that the energy crisis in the eurozone didn't turn out to be as terrible as imagined, the recession will be shallow, which will allow the European Central Bank to raise the deposit rate to 3.25-3.5%. And this is good news for the major currency pair.
Technically, the EURUSD daily chart continues to settle in the 1.0575-1.0655 range. It is unlikely that anything will change before Christmas. However, the risk of a speculative attack on a thin market is increasing. If the bears decide to do it, a break of support at 1.0575 might be a reason for short-term selling.