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.
