Top Forex Themes for 2016 |
- Top Forex Themes for 2016
- Is Buying Dollars in 2016 a Smart or Foolish Trade?
- EUR 2016 Outlook – Forget About Parity
- British Pound and the Defining Issues for 2016
| Posted: 28 Dec 2015 09:53 AM PST Top Forex Themes for 2016 Since the next two weeks are generally the quietest periods in the financial markets, we want to take this opportunity to think longer term and share with you our currency forecasts for 2016. We'll start with an initial review of the top themes and explore them in further detail as the week progresses in our outlook for each of the major currencies. But first – 2015 has been a big year for the foreign exchange market. Divergences in monetary policies led to strong moves in currencies with the U.S. dollar as the best performer. The U.S. saw its first rate hike in nearly a decade while other major central banks in the Eurozone, China, Canada, Australia, New Zealand and Japan eased. In response, the greenback climbed to multiyear highs and this strength translated into significant weakness for many major currencies along with a collapse for commodities. These are some of the milestones reached in currencies this year: The greatest risk for the financial markets and the global economy in the coming year is the feedback loop from the dollar and Fed policy. While the quarter point hike in December represents only a nominal increase in U.S. rates, the Federal Reserve expects to tighten 4 additional times next year which will have broad ramifications for currencies, equities and commodities. In mid-December, we published a piece outlining the Consequences of a Strong Dollar and a lot of these issues will return to focus in 2016. The first few months of the year should be good for the dollar as long as Fed officials don't backtrack on their hawkish views. There will be more hawks voting on the FOMC in 2016 than 2015 so the balance swings in favor of continued tightening. Between the warm El Nino weather and gas prices below $2.00 a gallon in some states, consumer spending should also rise in the first quarter. So while the dollar is rich, the path of least resistance is still in higher. However our outlook changes in the second half of 2016 as we believe rate hikes and the strong dollar will force the Fed to slow tightening makring the top for the greenback and the bottom for other major currencies. Here are some of the themes that we are looking for in 2016:
Monetary policy gaps will expand in the first half and narrow in the second – The Federal Reserve's rate hike ushers in a new phase of monetary divergence. In the coming year, the Fed will continue to reduce accommodation at a time when other central banks maintain and even expand their stimulus programs. While the Fed will be the only major central bank raising interest rates for most if not the entire year, in the first few months, investors will be actively thinking about who needs to move next. This speculation could accelerate as the strains of low commodity prices, slow growth and weak external demand hits many economies. But at the end of the day for most countries, the bar is high for additional easing. The global easing cycle is nearing an end as long as the Fed raises interest rates responsibility and avoids wrecking havoc on the financial markets. As such we believe that this past year's dominant trends should continue in the first few months and reverse as the year progresses and monetary policy divergences stop widening. Another way to look at this is that while we expect dollar strength to continue, it should abate through the year. Commodity prices will find a bottom in 2016. A strong dollar, weak global demand and high inventories have caused oil prices to collapse this year and while prices could fall further in the near term as the U.S. ends its 40 year ban on oil exports and sanctions are lifted on Iran, when the dollar peaks, commodities will bottom. The price of oil could fall below $30 a barrel but we do not see much weakness beyond that and by the end of the year we expect prices to settle closer to $40. In the long run, China's focus on domestic demand should be positive for energy prices. We expect further easing and a lower currency in the coming year. A bottom in commodity prices would not only affect the outlook for commodity currencies but could also mark a shift in G7 monetary policies as inflation starts to stabilize and turn upwards. Lifting inflation is the greatest challenge for many central banks and while a strong dollar lowers the value of local currencies, it also adds to disinflationary pressure by lowering prices and the question then becomes which has greater impact on growth and inflation – right now its lower commodities and not a lower currency. 2016 should also be a year of diminishing stock market returns. The era of easy money is coming to an end and the strong dollar along with Fed tightening will take a big bite out of corporate profitability. Single digit gains are the best that investors should expect in earnings growth. The prospect of a persistently strong dollar, sluggish global growth and lower commodity prices in the first half of the year means that earnings and stocks could suffer. We are looking for a correction in equities in early 2016 that could trigger a flight to safety in the currency market. At many points in the year politics will overshadow economics. We have the U.S. election, the U.K. referendum, ongoing Eurozone refugee crisis, possible showdown with Russia and risk of more aggression by ISIS. The U.S. election is definitely a second half story and while there are a lot of different factors at play this year according to our study, the EUR/USD has a lower bias during U.S. election years. In the 10 elections going back to the 1970s the EUR/USD weakened in 8 out of the 10 periods. The U.K. referendum poses a major risk that we will explore in our sterling outlook while the risk of more aggression by ISIS, possible show down with Russia and the ongoing refugee crisis has the greatest impact on the euro. There's a lot more to explore and we will do that in the individual currency outlooks but for now, these are some of the most important themes that we believe will dominate trading in the coming year. |
| Is Buying Dollars in 2016 a Smart or Foolish Trade? Posted: 28 Dec 2015 09:51 AM PST Is Buying Dollars in 2016 a Smart or Foolish Trade? 2015 has been a great year for the U.S. dollar but with only 5 trading days left many investors are wondering if being long dollars in 2016 is still a smart trade. December has been a difficult month for the greenback with dollar bulls struggling to maintain control. The Federal Reserve raised interest rates for the first time since June 2006 but instead of appreciating, the dollar erased nearly all of November's gains. Now many investors are wondering that if a rate hike and hawkish forward guidance can't lift the dollar, is it foolish to be buying greenbacks in 2016. To answer that question we have to understand why investors sold dollars in December. The bet that the dollar would rise in 2015 was one of the world's most crowded trades and according to the CFTC's Commitment of Traders report, forex futures traders were busy adjusting positions ahead of the December 16 FOMC meeting. The biggest changes were in euro and yen where investors aggressively cut their short euro and short yen positions. This means that investors started to unwind their long dollar trades ahead of FOMC and based on the price action after the meeting, liquidated further after the rate hike. Buying dollars became a very crowded trade in 2015 and a lot of money moved to the sidelines at the end of the year. This means there's money to put back into play in 2016. Yet positioning was not the only reason why investors bailed out of the greenback. According to the following chart past tightening cycles have not been good for the dollar and this scared many investors. While USD/JPY generally appreciated leading up to the rate hike, on a number of occasions it reversed course after tightening but this cycle is different because the first few months of the year will be good for the U.S. economy and the dollar. The warm El Nino weather and low gas prices will boost consumer consumption, which is already supported by steady job creation, wage growth and consumer borrowing. The Fed also welcomes new hawks to their roster of FOMC voters. But first lets be clear, the Fed's rate hikes will not cause a recession. It may slow the economy in the second half of the year but contraction is highly unlikely. Some investors are worried that the recent move by the Fed could trigger a recession but there are very few indicators and low oil prices have never caused a downturn in the U.S. Of course that could change as the Fed raises interest rates if they move too quickly. One of the greatest challenges is that higher interest rates do not hit the economy in predictable ways. They take time to percolate and it is difficult to predict the point at which the impact shifts from mild to severe. The quarter point hike is only a small tweak in rates and even if the Fed hikes by another 50 to 75bp next year (which is our preferred scenario), the impact on consumer spending and investment will be limited by the fact that most American mortgages are fixed rate, unlike Europe. Also businesses could view the Fed's tightening as a sign of confidence in the economy and they could be slow to adjust their investments. So at the onset the biggest impact will be on the U.S. dollar. More Hawks in the Birdcage in 2016 – The performance of dollar hinges on when the Federal Reserve will raise interest rates again. The next meeting is on January 26-27 and as there's zero chance that rates will be increased in the first few weeks of the New Year, consolidation in the dollar is likely. However if the Fed maintains an optimistic view on the economy, expectations for a rate hike in March will grow, leading to renewed strength for the greenback. It is important to understand that with each new year comes a new group of Fed Presidents and in 2016 4 votes rotate. Four hawks and 1 dove will replace 1 hawk, 1 dove and 2 neutrals. So the balance swings in favor of more consistent tightening. So while the dollar is rich, we believe the path of least resistance is still in higher in the first half of the year. Our outlook changes in the second half of 2016 when we believe rate hikes and the strong dollar will force the Fed to slow their pace of tightening marking the top for the greenback and the bottom for other major currencies. Election years are good for the dollar. The table below shows that the Dollar Index increased an average of 5% during an election year with the index rising 8 out of the last 10 periods. In 1 of the 2 years that the Dollar Index declined, the greenback lost approximately 0.5%. While it can be argued that Fed policy is not affected by elections, the time of major monetary policy shifts has often coincided with presidential elections. The second chart was created by the Washington Post and while their data only covers 6 election cycles, there's definitely a notable trend. Technically there appears to be a double top forming in the Dollar Index. However 96 is a fairly significant support level that should hold and we expect the index to make another run for 100 after which it should test the 61.8% Fibonacci retracement of the 2001 to 2008 decline near 102. |
| EUR 2016 Outlook – Forget About Parity Posted: 28 Dec 2015 09:47 AM PST EUR 2016 Outlook – Forget About Parity By Kathy Lien, Managing Director of BKAsset Management Six years after the financial crisis and the European Central Bank is still struggling to turn around their economy. As recently as December, they increased stimulus in a desperate attempt to revive growth and drive inflation higher. This illustrates how deeply entrenched the slowdown is and how poor of a job Eurozone policymakers have done this past year. In the third quarter, the Eurozone economy expanded by a mere 0.3%. During this same period the U.S. economy grew 2%. Inflation is low around the world but the approximately 10% slide in EUR/USD combined with the full scale QE program launched in early 2015 should have been more effective in boosting inflation, which ran at a 0.2% annualized pace in November – well short of the central bank's 2% target. 2016 brings more challenges for the Eurozone economy. As for the currency, forget about parity. Technically, there's only 2 important support levels in EUR/USD – the 12 year low of 1.0459 and parity. |
| British Pound and the Defining Issues for 2016 Posted: 28 Dec 2015 09:43 AM PST British Pound and the Defining Issues for 2016 By Kathy Lien, Managing Director for BK Asset Management 2016 will be a defining year for the British pound – a year when politics will overshadow economics. Considering that sterling ended the year near 7 month lows against the U.S. dollar, some of our readers may find it surprising that the U.K. was one of the best performing G10 economies. However according to the latest figures for the third quarter, the U.K. economy grew at an annualized pace of 2.1% which matches the pace of U.S. growth. In contrast the Eurozone and Japanese grew 1.6%, Australia expanded 2.5% and Canada contracted by 0.2%. There's also very little debate that the Bank of England will be the next major central bank to raise interest rates. Yet sterling benefited from none of this and instead weakened versus the euro, Japanese Yen, U.S. and New Zealand dollars over the past 6 months. Part of the underperformance was driven by U.S. dollar strength but slow U.K. wage growth, mixed data and cautious policymakers has the market looking for rates to rise in 2017 and not 2016. We believe the market is underestimating the Bank of England and the U.K. economy because 2016 should be a year of strong growth. Consumer spending is the backbone of the economy and sales surged in the month of November. While wage growth slowed, labour force participation rates remain near their highest levels in 20 years and service sector activity is accelerating according to the latest reports. As the labor market tightens and inflation bottoms out, wages should rise as well. Slow Chinese and Eurozone growth poses a risk to the economy and the manufacturing sector but the U.K. is still expected to be one of the fastest growing G10 economies in 2016. From the perspective of growth alone, the Bank of England should raise interest rates in the first half of the year. However there are 2 primary issues holding the central bank back – low commodity prices and the risk of Brexit. Oil prices could remain low for a large part of the year and as of November consumer prices are running at a 0.1% annualized pace, which is far short of the central bank's forecast. Considering that the Federal Reserve raised rates with yoy inflation at 0.5%, the BoE may not need to see CPI above 1% before tightening monetary policy but they could be reluctant to do so until there is greater clarity on Britain's position within Europe. The greatest risk that the U.K. economy and the British pound faces in 2016 is Brexit. If Britain maintains a free trade agreement, pursues very ambitious deregulation of its economy and opens up trade almost fully with the rest of the world, the best case scenario calculated by Open Europe, a UK lobby group estimates that a Brexit could lift UK GDP growth by 1.6% in 2030. However in the worst case scenario where the U.K. fails to strike a trade deal with the EU, Brexit could cost the economy as much as -2.2% in GDP growth. Realistically, the best and worst case scenarios are not the most likely outcomes. Predicting the long term impact of Brexit is nearly impossible at this stage because we don't know what the terms of the new relationship will be and we won't know until well after the referendum but in the lead up and immediate aftermath of the vote, we expect significant volatility and most likely weakness in sterling and other U.K. assets. It is not in the Bank of England's interest to raise rates during turbulent times and considering the greatest volatility for sterling will come in the lead up to the referendum, policymakers could err on the side of caution and forgo a rate hike. Of course there's another way to look at this – they could raise rates sooner, which would give them the leeway to cut rates later if the markets collapse. There's no set date for the in/out referendum – it could be in the second half of 2016 or 2017 which means if the BoE wanted to raise rates, they could do so the first half and avoid conflict with the referendum The Brexit vote will be a defining moment for not only the U.K. but all of Europe. Technically GBP/USD is very weak but there are a number of significant support areas below current levels. |
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