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What lies ahead in 2016 and what's the likely impact on FX?

business-articlesWhat lies ahead in 2016 and what's the likely impact on FX?

Financial markets had traumatic start to the year, with economists predicting 2016 will be a year of global economic crisis. 

So what’s coming right at us? We have the US election, the UK referendum on EU membership, the continuing Eurozone refugee crisis, a possible showdown with Russia, and the risk of more aggression from ISIS.

United Kingdom

As we move into 2016 we have already started to hear more noise about the vote for Britain to stay in/leave the EU. Most polls show the British public is nearly evenly divided about the country's future in the EU, with a slight bias towards staying. In addition there is lack of confidence in David Cameron’s ability to negotiate reforms.

A potential Brexit is the biggest risk facing the UK economy and the uncertainty leading up to the vote is likely to place a heavy cloud over appetite for the pound. Much will depend on the timing placed for the vote and how opinion polls are performing. The impact of Brexit is virtually impossible to forecast and this will, of course, add to the overall uncertainty. Whatever the outcome, it will be a defining moment for the UK and Europe that will also heavily influence the performance of Sterling.

Another big factor for the pound will be the timing of a UK rate rise (or, at least, the speculation over when a UK rate rise is likely to happen!). At the moment the mood is very dovish, with a rise pushed back to later in 2016 – and possibly to 2017. With the added volatility in the run-up to an EU-membership referendum, the Bank of England could hold fire on a rate rise until after the vote.

Alternatively, if data starts to improve we could see an increase sooner than the markets have currently priced in. That would avoid a clash with a referendum countdown.

United States

In December 2015 the US Federal Reserve raised the range of its benchmark interest rate by a quarter of a percentage point (to between 0.25 and 0.50%), saying that there's been considerable improvement in labour market conditions. However, policymakers said the federal funds rate is likely to remain for below long-run levels for some time, suggesting only gradual increases in the future depending on incoming economic data.

The key question in 2016 will be the pace of rate increases. As it stands, we're expecting further increases of between 0.75-1% and the momentum of the US dollar will depend on whether the pace of increases is faster or more gradual than is currently priced in. The positive labour market data received in early January has raised expectations that the tightening cycle could pick up speed.

It is election year in the US, and the countdown to November is likely to be highly vocal  leading to potential volatility in the US dollar and US equities.

With an exceptionally warm start to the winter, oil markets have begun 2016 poorly. The continuing downward spiral in oil is affecting the foreign exchange markets, especially the US dollar. We are seeing a sell-off in commodity-related currencies in favour of the US dollar, and the Greenback could be further supported if the downward trend continues.

China

The financial start to 2016 has been extremely tumultuous, due to the situation in China. The Chinese equity market fell over 7% twice in one week, leading to a trade suspension. The slowdown in China and the People’s Bank of China's continued efforts to depreciate the yuan to help alleviate the fallout are both trends expected to continue in 2016.

The policy of weakening the yuan will enable China to maintain its competitiveness but will escalate tensions related to so-called currency wars. The US, other Asian, and emerging market economies will not welcome the current policy of yuan depreciation.
 
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