Annual Round-up

The CAD was the worst performing currency of 2015 as it lost over 16% on the year while making 11- year lows. The Canadian economy suffered a technical recession in the first half of the year. The Bank of Canada responded with two interest rate cuts early on which seemed to help the economy get back to at least flat growth. The biggest culprit, as you can pretty well guess, was the crash in the price of oil. Unfortunately, the price of oil has not bottomed yet. With the Iranian sanctions coming to an end, more oil will be added to the current supply glut, which is also increasing thanks to the mild winter season in North America due to the warm El Nino weather pattern. With oil currently trading around the $37 handle a fall to $20 could be in the cards. If the price of oil does fall further don’t be surprised if the Bank of Canada offers up more interest cuts and possibly unconventional policies such as negative rates and/or QE, if things really go downhill. As we have seen with other central banks, dovish monetary easing doesn’t necessarily translate into an increase in a country’s exports especially when the world is struggling with insufficient global demand – thus some central banks have been forced into the use of unconventional policy tools.

The USD powered ahead for the first three months of 2015 on the premise that the U.S. Federal Reserve was getting ready to raise interest rates while the rest of the world was just kicking off another round of monetary easing. While this monetary policy divergence was well telegraphed, and thus easy to prepare for, it was the unexpected moves that caused the most damage. The breaking of the Swiss franc/euro peg in January and the Chinese yuan devaluation in August caused market participants undue stress and reminded everyone that forex markets are not for the faint of heart. 

Come to think of it, the policy divergence theme was also full of false starts as the Fed tied any rate increases to economic improvement amid signs of an inconsistent recovery. The market was blindsided when the Fed downgraded its predictions for U.S. growth and inflation at the March FOMC meeting instead of raising interest rates for the first time since 2006, sparking a selloff in the USD. This sapped the momentum from the US dollar index as it peaked in March and fell prey to false starts after each of the next four meetings. The second last meeting of the year in October was the turning point for the USD as it gained strength in anticipation of a December rate hike. Unfortunately, the USD was side swiped once again after ECB President Mario Draghi under delivered at the ECB policy meeting. A massive short squeeze in the EUR/USD ensued, which temporarily put a dent in the divergence theme. This helped to temper the market’s reaction to the Fed’s rate hike in December.

There is no question that the USD was the top performer of 2015, led by the divergence in monetary policy between the Fed and the rest of the main central banks. Now that the Fed has its first rate hike under its belt it is looking to make four additional hikes in the year ahead. The Fed will have more hawks in the birdcage in 2016 so the case for monetary tightening and a higher USD can easily be made. However, the divergence case may have a short shelf life since we think that the global easing cycle is nearing an end. How this plays out remains to be seen as each of the other central banks and foreign governments will have their say as well. Let us take a brief look at the majors.

The Japanese yen was the best performing currency after the USD. The yen was sought after as a safe haven during geopolitical events such as the Paris terrorist attacks. It also remained strong because the Bank of Japan did not find the need to offer any new easing policies. At this point, the only way we see the BOJ adding to its easing bias is if the fallout of the Chinese slowdown takes a turn for the worse. As we will shortly see, this wild card will be in play for many of the world’s central banks.

The one thing we can say for sure about the National Bank of Switzerland is that they are not ready to throw in the towel on keeping their currency from appreciating. They may change the goal posts from time to time, like they did in early January, but they are not about to quit. The biggest threat to currency appreciation would be a slowdown in the Eurozone economy which would cause the ECB to act again. Thus, the central bank could go further into negative rates if the circumstances warrant it.

The UK economy was one of the best performing economies in the first half of 2015 which caused many to believe that the Bank of England would be the second major central bank to raise interest rates. However, the economy tailed off in the second half of the year as the commodity sector continued to crash causing the market to push out the BOE’s interest rate hike. The greatest risk to the GBP in 2016 is the threat of Brexit - "British exit". Brexit refers to the possibility of Britain's withdrawal from the European Union. Prime Minister Cameron has promised a referendum but no date has been set as of yet. Leaving the EU would have an enormous economic impact on the UK economy, thus Brexit is a black cloud over the future.

The euro was down about 10% for the year but was able to hold its March low prior to the December ECB meeting which caused it to move up on a classic short squeeze. The fact that the Eurozone continues to struggle after the great financial crisis of 2008 and the European Sovereign debt crisis of 2010 is not surprising and only reinforces the problems with a currency union. The biggest drawback of the union is that they only share a currency but not revenue and taxation policies. Be that as it may, the ECB has done what it can to stimulate growth and it will continue to do so in 2016, considering it was the last one to the global easing party. Geopolitical risks in the Ukraine and the Middle East will continue to be the black clouds over the Eurozone in 2016.

The AUD and NZD were down 10.72% and 12.35% respectively for the full 2015 year. However, those numbers are misleading because for the last 3 months of 2015, the NZD and AUD were the top performing currencies with gains of 6.76% and 3.87% respectively. These gains came despite continued commodity price pressures in Q4 2015. In the first nine months of the year, the two commodity currencies struggled due to the high USD and the slowdown in the Chinese economy. The central banks of both countries responded with interest rate cuts and good old fashioned jawboning. By the time the fourth quarter started, both banks made it abundantly clear that they were satisfied with their country’s economic progress signalling the end of monetary stimulus. Coupled with a bottoming of key commodity prices for each country in the month of December - dairy for New Zealand and iron ore for Australia – the way was cleared for a rally into year-end for both currencies. The key for each currency in 2016 will be the performance of the Chinese economy. If China continues to sputter than both currencies will suffer. On the other hand, if China begins to turn the corner then both currencies will finish 2016 on a positive note. In either case, the NZD should outperform its commodity brethren, the AUD, due to its greater exposure to the Chinese consumer in the form of soft commodities (food) rather than hard commodities which are more geared to the investment and infrastructure side of the Chinese economy.

So there you have it, a brief synopsis of each of the key currency majors that we follow. We have taken for granted that we have entered into the second phase of monetary policy divergence. This phase will be marked by interest rate hikes by the Fed while other central banks stand pat or extend easing. It will be interesting to see how long this divergence lasts, considering that on the surface; it would seem that we are closer to the end of the global easing cycle rather than the middle. Once the Fed hints that it is close to ending its course of rate hikes then and then will the USD crest and turn downward.