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Best forex investments: will interest hikes lift USD in 2022?


Interest rate hikes to curb inflation are widely anticipated in 2022. It could have a major impact on the foreign exchange market.

The US Federal Reserve (Fed) said on 15 December that it will “reduce the monthly pace of its net asset purchases by $20bn for Treasury securities and $10bn for agency mortgage-backed securities”. The increase in tapering signalled sharper interest rate hikes in the next two years.

“The Committee also signalled a significantly steeper path of rate hikes in the coming two years than appeared in the September projections, with three rate hikes each in 2022 and 2023, and a further two hikes in 2024,” said Dutch bank ABN AMRO on 17 December. 

The Fed is aiming to keep the inflation rate at 2% over the longer term. It’s currently at 6.8% – the highest since 1982. 

With much of the world experiencing an accelerating rate of inflation this year, curbing it by raising interest rates has become a key focus for many central banks.

Interest rates and inflation are two key drivers in currency exchange rates. Low interest rates can weigh on the value of a country’s currency. Currency depreciates in an inflationary environment. As a result, interest rates and inflation could remain trending topics in the forex market over the next two years.

Ahead of 2022, let’s look at the most traded forex pairs in 2021 and explore what could potentially be the best foreign currency to invest in.

Most traded forex pair

Currencies are traded against each other as exchange rate pairs – a trader will need to buy or sell one currency against another.

According to the 2019 triennial survey by the Bank for International Settlements (BIS), the most traded forex pair by volume is the euro and US dollar. 

The US dollar is the world’s reserve currency. Up to 90% of all forex transactions were made in US dollars, BIS data showed.  

The top six forex pairs (by volume) in 2019

EUR/USD

 EUR/USD price chart

According to the BIS survey, the EUR/USD is the most traded currency pair in the global market, accounting for 24% of daily over-the-counter foreign exchange turnover volume in 2019.

“The popularity of the EUR/USD pair comes from the fact that it is representative of the world’s two biggest economies: the European single market and the US,” wrote online broker IG.

With the Fed set to hike interest rates next year, the USD is widely expected to appreciate in 2022. The US dollar index hit a 17-month high at 96.88 on 24 November. Although the index has since fallen to 96.36 at the time of writing (22 December), it remained around its one-year high – up 7.5% from the beginning of the year.

The USD has been one of the best performing currencies in 2021.

Meanwhile, the European Central Bank (ECB) has adopted a more dovish stance. The market is not expecting an interest rate hike in the next 12 to 18 months, said Dutch bank ABN AMRO.

The ECB’s Governing Council expects “key ECB interest rates to remain at their present or lower levels until it sees inflation reaching 2% well ahead of the end of its projection horizon and durably for the rest of the projection horizon,” reported ABN AMRO.

The ECB forecast the inflation rate to rise to 3.2% in 2022, up from 1.9% in September this year. The rate is expected to decline to 1.8% in 2023, remaining at that level until the end of 2024.

As a result of the divergence in policy between the ECB and the Fed, the euro is expected to come under pressure in 2022. 

“Aside from temporary US-dollar strength, another reason for the euro’s recent weakness is the ECB’s differing approach to monetary policy compared with central banks in the US and Canada. While the Fed has started a discussion on reducing bond purchases, the ECB is likely to continue with asset purchases for the foreseeable future,” said RBC Global Asset Management in its October report.

Consequently, RBC said in its October report that it has cut its EUR/USD forecast to $1.27 for the next 12 months, compared to the previous projection of $1.30.

The euro index has been falling this year. On 21 December, down 7.8% compared to 122.25 at the beginning of the year.

Given the diverging performance of the US dollar and euro, this could be one of the most profitable forex pairs in 2021.

USD/JPY

USD/JPY price chart

According to forex trading tools and data provider FXSSI, the Japanese yen could be one of the safest currencies to invest in. 

“The country’s inflation rates have been low for extended periods of time. This currency is not pegged to the US dollar or the euro and therefore retains its purchasing power even in times of a crisis,” said FXSSI.

The currency pair is known for its high liquidity – the yen is the most heavily traded currency in Asia.

USD/GBP

USD/GBP price chart

Following the UK’s withdrawal from the EU, uncertainty over the country’s future trading relation with the bloc has weighed on the British pound (GBP).

“The British pound has not been among our favourite currencies over the past few years due to Brexit uncertainty, a sizable current-account deficit and a lack of competitiveness relative to its largest trading partners,” said RBC.

With political tension over the post-Brexit trading arrangement, Northern Ireland and a potential referendum on Scottish independence, RBC believes “the macroeconomic landscape continues to suggest that the pound will underperform versus the euro, the yen and cyclical currencies”.

RBC expects the pound will appreciate against the US dollar to $1.40 in 2022, up from the existing rate of $1.33 (22 December).

Highest volatility forex pairs – USD/TRY

USD/TRY price chart

US/TRY is the most volatile forex pair. To boost exports, investment and create jobs, Turkish President Recep Tayyip Erdoğan has implemented a series of interest rate cuts in recent months amid double-digit inflation. This has caused the lira exchange rate against the dollar to plummet.

The USD/TRY started the year at 7.44 and hit 16.66 on 19 December.

Earlier this week, the Turkish government offered compensation for exchange rate losses for savers if they hold their money in lira, instead of converting the money into the US dollar or gold.

Following the announcement of this new saving scheme, the lira rebounded. It’s gained nearly 23% over the last two days, making it the most volatile currency this year. The USD/TRY exchange rate was at 12.52 on 22 December.

Keep in mind that price performance is no guarantee of future returns. And never invest more money than you can afford to lose 

FAQs

Read more: USD/TRY forecast: will the lira’s rollercoaster ride continue?

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