Forex Markets – 2016 Outlook

Jan 04 2016, 9:44 am

With the first trading week of the New Year, 2016 underway, it’s back to business for the markets at large. Last year witnessed the historic Fed rate hike liftoff, and the focus into the next year brings about some interesting questions as far as the currency markets are concerned. So what does the New Year hold for the forex markets and which are the currencies worth keeping an eye on? Here’s our outlook for 2016.

USD: It is no question that the US Dollar has been on a remarkable trajectory since the times of QE, which now; looking back seems to be history. While there were doubts if the Fed would be able to pull off the rate hikes, it was a close call as the Federal Reserve finally managed to pull the trigger in its December meeting, hiking the benchmark US interest rates to 0.75%. The Fed forecasts four rate hikes in 2016, which should ideally bring the US interest rates to 1.75%, if all goes to plan. While it is unsure and a bit too early to call it a done deal, expect the Fed to make at least one more rate hike in 2016. The year ahead is also important as the US elects its 45th President. The US general elections are due on November 2016 and the Fed could ease its foot off the rate hike pedal around Q3 and Q4. There is a popular notion that the Fed doesn’t play around with monetary policy as the clock ticks closer to the election month, however on two past occasions (1988 and 2004) the Fed did hike rates into the election year. Of course, the rate hikes will be data dependent. For the US Dollar, with another rate hike due, it is unlikely to see the Dollar Index head much further up which could see a short term recovery of its peers, especially the commodity risk currencies.

US Dollar 2016 Outlook: Expect at least one more 25bps rate hike from the Fed. The US Dollar could move sideways rather than make any significant breaks either to the upside or downside.

JPY: The Bank of Japan will soon have to decide what it must do with its burgeoning balance sheet. For the most part last year, the Yen has been largely flat and various BoJ officials have given the view that 125Yen is a rather comfortable level to maintain as far as the exchange rate is concerned. Among all Central bankers, BoJ’s Kuroda has been the most optimistic as far as inflation is concerned. The markets will get to see if this bullish bet from Kuroda will pay off as the fiscal year in April kicks in. The question is if the BoJ’s inflation will hit the 2.0% target rate and what could the BoJ do in order to push inflation higher amid an environment of weak commodity prices. At the December 2015 BoJ meeting, the Central Bank announced an additional 300 billion Yen purchases of ETF in addition to the existing 3 trillion. The new ETF purchase program is due to kick off from 2016 with the ETF’s tracking the Nikkei 400 index. While the Yen initially weakened on the news, investors began to buy back the Yen in what was seen as a weak effort to boost the BoJ’s stimulus program.

Yen, 2016 Outlook: Will the BoJ’s inflation hit the 2.0% target rate? Will there be more easing from the BoJ?

GBP: Once a front runner for interest rate hikes, the low inflation put a dent on the BoE’s plans. Making things worse was the slowdown in the average wage earnings which eased back after peaking at 3.0% mid-way. The markets now expect the BoE to hike rates in 2017, around the first or second quarters, but for this to happen, there has to be evidence that inflation would return back to the BoE’s 2.0% target rate alongside a pickup in wages. If inflation wasn’t enough, the UK will most likely see the ‘Brexit Referendum’ which could prove to be critical. With David Cameron failing to make any major gains with his negotiations with Brussels, there is strong speculation that the referendum could be called for around July 2016. While the markets by and large expect the Brexit referendum to result in a vote to stay in the EU, there is no ruling out of a surprise opposite outcome. In the run up to the event, the British Pound could see further losses, especially against the Euro. EURGBP touched down to 0.70 levels last year but soon enough managed to reverse off the lows and could potentially continue to move higher until the uncertainty is removed from the equation.

British Pound, 2016 Outlook: Will inflation return back or at least show signs of inching back to the BoE’s 2.0% target rate? Will wage growth pickup pace again? Will the UK vote to stay in or out of the EU if the referendum is held this year?

Oil: Oil prices continued their descent last year as OPEC stood by and kept production unchanged. While Oil prices briefly touched down to 10/11 year lows near $35, there were some concerns voiced by other Oil producing nations. The big question is if OPEC will continue to keep production unchanged and will Oil prices see further declines? Furthermore, the effects of continued decline in Oil prices could keep inflation levels low in many economies. Goldman Sachs famously forecasted that Oil could touch down to as low as $20 a barrel and this could very well be true if the current status quo remains, one that of the markets being oversupplied while demand remains weak.

Oil, 2016 Outlook: Will Oil prices ever see the $50 handle again? Will there be further declines in store and could we expect Oil to hit the $20 barrel? Will OPEC stand by or will the cracks break into a full blown crisis within the Oil producing nations?

Euro: 2015 was marked with talks of EURUSD parity but that soon changed towards the second half of the year as the Single currency proved to be resilient. Thanks to Draghi’s ECB meeting in December, the European Central Bank refrained from adding further QE, which sent the Euro sharply higher. The fact remains that with inflation still low, it would only be a matter of time before the ECB injects additional stimulus. With the conventional monetary policy tools almost exhausted, as the ECB cut its deposit rates to -0.30% and the benchmark lending rates at 0.10%, the ECB could soon run out of options. 2016 is most likely to see continued speculation on ECB’s additional stimulus program unless inflation manages to turn around and show evidence of a pickup in consumer prices. If not Q1, Q2 2016 could prove to be vital for the Euro.

Euro, 2016 Outlook: Eurozone inflation will remain a key talking point in 2016 with the ECB running out of options. The inaction by Draghi at the December meeting is likely to limit any verbal talk down of the exchange rate with skepticism and would only leave the ECB to walk the talk. EURUSD could very well finally see the parity of 1.0 in 2016

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John has over 8 years of experience specializing in the currency markets, tracking the macroeconomic and geopolitical developments shaping the financial markets. John applies a mix of fundamental and technical analysis and has a special interest in inter-market analysis and global politics.

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