December 10, 2015

What’s Next for Currency Markets in 2016?

BNY Mellon’s Markets Strategy team discusses the euro-area, dollar strength and oil price weakness

This year provided more than its fair share of drama in the currency markets, an astonishing move seen in the Swiss franc as the Swiss National Bank abandoned its ceiling against the euro (EUR) through to the near exit of Greece from the euro-area. So what’s in store for 2016? If we are in an environment where the only thing that matters to investors is monetary and currency policy settings then it is reasonable to argue that there is the potential for a bubble to build. It’s against this backdrop that we launch our 2016 preview which you can view here. The highlights are below:

December Hikes Forthcoming – Then What?: Given that we see signs of tightening credit conditions already, along with the still weak inflation expectations and possible economic and market weakness due to the stronger US dollar (USD), the Federal Reserve faces a monumental challenge if it wants to raise the funds rate to 1.5% by the end of 2016.

The Euro-area: A weaker EUR might eke out a modest rise in market share for euro-zone exporters, but then, expansive monetary policy cannot be maintained without encouraging asset price instability, as any German property agent will tell you. Monetary policies globally are approaching their limit; and European Central Bank President Mario Draghi may have come to some similar conclusions.

Dollar Strength and Oil Price Weakness?: Following a direct statment from Mario Draghi that “the degree of monetary policy accommodation will need to be re-examined at the Governing Council's December meeting”, the price of Brent crude topped out and began a nine day fall that saw it lose well over 10%. Given this, it seems reasonable to suppose that renewed downward pressure on oil prices is likely to emerge going into 2016.

Commodity Currencies: China’s economic slowdown has hit commodity prices hard. There could be more where this came from: the Chinese economy continues to lose momentum and the legacy of surplus capacity from its “growth at all costs” model - prevalent across China, and not just in its housing sector - poses a clear risk to longer-term growth and price stability.

The Outlook for Sterling (GBP): It is clear to most that GBP is no longer particularly undervalued (particularly against the EUR) following six years of relentless gains. It is also clear that with the eurozone crisis abating (for the moment at least) GBP’s safe haven status is becoming of far less relevance to investors. Put simply, it looks to us as if 2016 will be the year that GBP finally loses its shine.

To read our full preview of 2016 and watch the videos where we answer the key questions that will shape markets next year, please click here.

See here for commentary disclosures