What does 2016 hold for Forex markets? – A market analysis looking at currencies by region

By Cina Coren, Daily Forex

It certainly isn’t easy to anticipate what the markets will do in in 2016 but based on events that have taken place in recent months, it is possible to makes some fairly tentative predictions.

When it comes to the U.S. dollar, the signs are pretty clear. Now that the Fed has raised interest rates and ended its long-standing Zero Interest Rate Policy (ZIRP), the US Dollar is well-positioned versus major counterparts through the start of 2016. Analysts see the USD continuing to get stronger and commodity currencies mostly getting weaker. The next strongest trend after USD/CAD is short GBP/USD.

Forecasters believe that Fed decisions in 2016 will prove to be a major force driving currency prices. The Fed expects to introduce four more rate hikes during the year totaling a cumulative 100 basis points. The markets, however, predict not more than two hikes which may prove to be enough to make the difference between a continued US Dollar uptrend or trend reversal in a world with negative nominal interest rates.

There is less agreement concerning the next two big global currencies after the USD, the Euro and the Japanese Yen. Indeed, the Fed’s hike contrasts sharply against the European Central Bank, which moved to cut interest rates just a week before the FOMC decision, sending the EUR/USD pair as high as 1.1050.

The central bank also decided to extend its QE program to at least March 2017 (it was initially expected to end in September 2016) and to reinvest principal payments to keep the balance sheet sizable. Projections show little change to real GDP forecasts but if the Eurozone recovers quicker than expected, the euro could slowly recover and parity with the USD probably won’t happen. The volatility in the euro looks likely to increase as it has become a currency of choice for carry trades.

Japanese Yen

When it comes to the yen, there is no solid opinion of where it will be in 2016.

The yen exchange rate was also marked by volatility in 2015, bouncing between 118 and 126 yen to one U.S. dollar. The Japanese economy fell back into recession during the year and is seen as not being in a position to strengthen next year. Most analysts predict the Bank of Japan will respond as it has been doing—by introducing more monetary stimulus that subsequently drives down the value of the yen. A weak yen has significantly weakened corporate revenue, and multinationals should be prepared for more of that in 2016.

However, the yen is also being seen by the market as a ‘safety’ currency, so when the markets go into low risk mode, money flows into the yen and the currency strengthens making short JPY a much less desirable trade. Opinion among analysts is quite evenly split on the yen regarding whether it will strengthen or weaken over the year to come.

The Loonie

A weaker USD would be good news for commodity prices and hence the Canadian dollar. The current negative correlation between monthly changes in the broad dollar index and the price of WTI remains strong and could surprisingly turn back up to $50 or even $57 by the end of 2016. With Canadian assets selling at a discount now, foreign investors can grab at the opportunities and this would benefit the country’s foreign direct investment numbers into 2016. USD/CAD can come close to the lower end of the 1.25-1.35 trading range.

China

The biggest currency story in 2016 will be the Chinese yuan becoming more closely tied to world currencies other than the U.S. dollar and the very significant business risk this connection represents for multinational companies who have been highly exposed to China’s yuan.

When China surprised markets in August by allowing the yuan to fall by nearly 2% against the dollar it hit a four-year low against the dollar which led to volatility for many Asia-Pacific currencies and caused a ripple effect around the world.

China is positioned to widen the yuan trading band even further in 2016, in large part because the RMB will become the fifth currency in the International Monetary Fund’s “basket of reserve currencies.” As China moves to a freely floating trading band, the yuan will likely experience unprecedented volatility and will, for the first time, become a risk that many multinationals will actively manage.

United Kingdom

The UK seemed to have pulled itself out of a possible period of deflation in 2015. Recent data indicates that the consumer price index is up by 0.1%, suggesting a possible BOE rate increase from 0.50 per cent to 0.75 per cent in the first or second quarter of 2016. The decision will depend on how economic growth, earnings and productivity develop over the first few months of the year, as well as just how quickly inflation moves up during the same time period.

Still, there is mixed feelings about how the GBP will perform in 2016. Expectations suggest that the Bank of England (BoE) will opt to leave interest rates ultra-accommodative for the foreseeable future and the Pound is likely to experience a further softening in 2016, shoring up the EUR/GBP exchange rate.

Increased GBP and euro volatility should be anticipated as the UK’s referendum on European Union membership approached.

Cina Coren is a former Wall Street broker and financial advisor. She holds a Master’s degree in Communications and spent many years writing for international news outlets and journalistic publications. Today, Cina spends most of her time writing internet articles and blogs, and reading various newspapers to stay on top of the news.