What to expect in global currency markets in 2016

Enrique Díaz-Álvarez31/Δεκ/2015Currency Updates

2015 has been a far more volatile year in the currency markets than many would have anticipated 12 months ago. The driving themes throughout the year were:

1) The relentless strengthening of the US Dollar, as the Federal Reserve first intimated and finally delivered the first of its interest rate hikes.

2) The sharp correction in emerging market currencies, driven by both higher US interest rates and the collapse in commodity prices.

The year began in stunning style with the shock removal of the Swiss Franc’s three-year-old Euro peg, causing the currency to soar by as much as an astonishing 40% in just one day. Not long after, the European Central Bank’s President Mario Draghi announced its “big bazooka” of quantitative easing in a bid to breathe life into the stagnant Eurozone economy.

During the spring the Greek crisis and fears of an exit from the Eurozone were dominating the headlines, while the UK General Election delivered a surprisingly comfortable victory for David Cameron’s Conservative Party.

Oil prices have continued their sharp trend downwards, falling to a six-year low below $35 a barrel in December.

Emerging market currencies have sold off across the board, compounded by the expectation of an interest rate hike in the US and economic slowdown in China. Many, including the Russian Ruble, Brazilian Real and South African Rand have all fallen to all-time lows in 2015.

Finally, after much anticipation and speculation, interest rates went up in the US in December when the Fed announced it would be hiking its benchmark interest rate for the first time in almost a decade.

So what does 2016 hold for the currency markets?

The foremost question for the FX markets in 2016 is whether the two driving trends we mentioned above (the rise of the Dollar and the drops in emerging market currencies) will continue.

As to the first, our forecast is that yes, the Dollar rise will continue, albeit at a more gradual pace. The divergence in monetary policies between the Fed in the US and almost every other major central bank in the G10 countries will provide further tailwinds for the US currency. And we don’t think interest rate markets are pricing in a sufficiently aggressive schedule of Fed hikes.

The December “dot plot” from the Fed suggests that policymakers in the US expect to hike three or four times in 2016, roughly once a quarter or the equivalent of every other meeting. This will likely provide good support for the US Dollar next year and it puts emerging market currencies under increasing pressure, especially if, as expected, commodity prices remain at their currently subdued levels.

In contrast, the Euro looks set to remain under pressure following the recent expansion in monetary easing measures by the European Central Bank. It’s now likely that the ECB will expand its quantitative easing programme further at some point in the coming year, particularly if inflation fails to show a pick-up back towards its 2% target.

Closer to home, we expect the Pound to tread a middle path, up against the Euro and down versus the US Dollar, with the Bank of England set to follow the Fed by hiking rates at some point in the third quarter of the year.

On the politics front, the Presidential election in the US will come into focus towards the back-end of 2016, while the UK’s EU referendum will be a major talking point and could bring downside risks for Sterling.

As far as the second major question is concerned, the fate of emerging market currencies, we think that we’re in the process of establishing a bottom in most of the main currencies, such as the Brazilian Real and the South African Rand, etc.

Firstly, it’s difficult to see commodities selling off much further without a global recession which we’re certainly not expecting. Secondly, while most emerging market corporate debt has increased significantly, it has mostly done so in local currency, which makes the problem manageable for the local central banks and governments.

Finally, after the sometimes dramatic sell-offs seen last year, most of these currencies are at extraordinarily cheap levels which will enhance competitiveness and help attract commercial and investment flows over the next year.

If the past 12 months are anything to go by, we’re in for an exciting year in the currency markets!


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Written by Enrique Díaz-Álvarez

Chief Risk Officer at Ebury. Committed to mitigating FX risk through tailored strategies, detailed market insight, and FXFC forecasting for Bloomberg.