2015 Review: How divergence once again dominated forex during 2015
Two key events will come to define 2015 in terms of the forex markets. The first one is the acceleration of the great divergence with the US Federal Reserve raising interest rates by 0.25% for the first time in over nine years on December 16. The other major event was the inclusion of China’s currency in an arcane IMF accounting unit, which in a sense conferred the CNY with a coveted reserve status.
The US move comes in sharp contrast to what’s happening in the Eurozone, setting up a level of divergence between the two currency blocks not seen in over two decades.
The European Central Bank unleashed a EUR 1.1 trillion quantitative easing programme in March and then in December extended it into 2017 from 2016 with another EUR 360 billion to come. Interest rates were also cut further into negative territory as the Eurozone battled to stave-off deflation.
Both events were heavily anticipated, neither was of much surprise when it happened, but they have been key drivers behind forex trends this year – namely a strong USD against pretty much most of the other currencies with the EUR remaining weak.
The first half of the year was very much dominated by the Greek debt crisis, which had at times raised questions over the viability of the Eurozone itself, which undermined the EUR. Following much drama, a solution of sorts was cobbled together allowing some confidence to seep back into the single currency.
On the other side of the Atlantic, the Fed’s actions come on the back of falling US unemployment, a steadily growing economy and some signs that inflation could be starting to stir along with wage growth.
Nonetheless, the Fed’s move was also likely heavily linked to credibility. It must be one of the most telegraphed and anticipated rate rises in history. The fact it was so slow in coming is a reflection of the constant uncertainty that beset the global economy during 2015. The constant dithering over the rate rise was starting to call the Fed’s reputation into question.
CNY moves closer to challenging USD
The other major event was the inclusion of CNY in the basket of the IMF’s Single Drawing Rights – a sort of hybrid currency for settling accounts among member countries. The event was largely symbolic as the SDR is hardly used and is a throwback to the Bretton Woods fixed exchange rate system, which no longer exists.
For CNY to become a component of SDR means conferring it with reserve currency status. This reflects China’s ongoing economic and financial reforms to gradually make its currency more free floating and to develop its own domestic financial markets. This reflects its shift towards a consumer driven economy and away from exports and infrastructure development.
If the reforms are successful, CNY is likely, in time, to emerge as a genuine alternative to the USD in the global financial system as it is backed by the world’s second largest economy and its top trading nation.
In August, China surprised the world with a small 1.8% devaluation in CNY versus USD, which could be a precursor to more devaluations as it has been using up foreign currency reserves to defend the exchange rate.
Other events of note, were the ongoing plunge in commodities prices, which impacted currencies such as CAD and AUD, but also hammered many emerging market ones, such as ZAR and BRL. Many emerging market currencies were also hit by the impending US rate rise with concerns that some of them have borrowed heavily in USDs, which have been soaring in value versus their currencies.
Fairly uneventful for GBP
Though GBP was not an overly interesting currency in 2015, it’s sort of stuck in the middle between events in the US and the Eurozone, it did have one or two moments of its own. Notably, there was the UK election in May where the Conservative party defied opinion polls by actually winning outright, which buoyed GBP.
Otherwise, speculation over a rise in UK interest rates came to nothing, partly reflecting indecision at the Fed and also because the UK started slipping in and out of deflation. However, the UK’s economy, jobs and property markets were all bright spots.
Among the peripheral currencies, Switzerland shocked the world when the Swiss National Bank gave up pegging CHF to the weakening EUR and allowed CHF to soar by 30%. The SNB also slashed its already negative rates by another 0.50% to 0.75%.
Indeed, negative interest rates were an important sub-theme of 2015 with Denmark and Sweden also using them with the later also kicking off a quantitative easing programme. The ECB was the first major central bank to use negative interest rates when it started in 2014.