Forex: 2016 will be the year of accelerated divergence
In one key respect 2016 will be a follow on from 2015 and that is in the growing divergence in monetary policy between Japan and the Eurozone locked in quantitative easing programmes and the US, which as of December 16 is now in a moderate interest rate upswing. The UK straddles between the two contrasts having ended its QE programme years ago, but with a steady economy and falling unemployment, it could be under pressure to mimic the US with an interest rise of its own.
All eyes will be firmly fixed on the progress of the US Federal Reserve’s interest rates next year. They are anticipated by the Fed to rise from 0.25-0.50% to a median level of 1.375% - implying four rate hikes next year (market forecasts 1.25-2.25%). This will make Fed FOMC meetings an even bigger focus for markets.
Non-Farm Payroll numbers will continue to be closely scrutinized for clues on future rate hikes. The Fed believes the unemployment rate will pan out at 4.7% -- but beware if it falls further, which it could. as it is only 5% now. The other factor which will become an even bigger preoccupation for the Fed and markets is wage growth, which is currently running at just over 2%. If it hits 3% it could set alarm bells ringing at the Fed providing for a more hawkish stance on monetary policy.
Nonetheless, the Fed has reiterated that its monetary policy remains accommodative and has no intention of damaging consumer demand, which is arguably sensitive to mortgage rates if they go up too much. The US economy is expected to grow by 2.4% next year, compared with 2.5% anticipated for 2015 and 2.4% in 2014.
However, there are a number of tail winds, which could blow the Fed of course. Among them are growing problems in the credit markets, particularly for lower quality corporate credits and some emerging market country debt. The stock market also looks vulnerable to a big sell-off. Also, should China devalue CNY that to could rattle nerves in financial markets and place further upward pressure on USD.
Indeed, a number of other central banks in recent years have raised interest rates only to reverse their policies soon after. Therefore, it’s not beyond the realms of impossibility for the Fed to be forced to do a U-turn sometime next year or the year after, which would be bearish for USD.
Overall the outlook for 2016 is deeply uncertain. Also on November 8, the US holds its Presidential election, which could be another source of volatility for the markets – though traditionally the US Presidential cycle has been good for risk assets, such as equities, as the economy is geared towards creating ‘a feel good’ factor for voters.
ECB to put the pedal to the metal to defeat deflation?
The EUR has been in a bear market since May 2014 as the European Central Bank finally started to catch up with other leading central banks and pursue ever more unorthodox monetary policies culminating in its own quantitative easing programme, which started earlier this year. Next year could well see its QE programme stepped up as ECB boss Mario Draghi does whatever it takes to defeat deflation. He also seems keen to keep the EUR weak to help the region’s exporters.
Looking to 2016, Eurozone economic growth is expected to be around 1.6-1.8%, up on forecasts for 1.5% this year with once troubled periphery countries such as Spain and Eire doing particularly well. Inflation is forecast at around 1%. This is helped by the ECB’s accommodative stance and the collapse in commodity prices putting more money into the pockets of consumers and companies. A strong USD and a steady US economy should continue to support the Eurozone’s exports and large current account surplus.
Nonetheless, the Eurozone’s ageing population, struggles to balance public-sector books, the slowdown in emerging markets are still taking their toll. Also, there’s always the risk of another crisis in the rather accident prone Eurozone. But with economic growth appearing to be broader based the risks are a little less pronounced for the time being.
Providing the Eurozone can avoid straying into another crisis or severe deflation – then EUR/USD could be fairly close to bottoming out.
Likely trading range for EUR/USD: 0.9500-1.1500.
Steady as she goes for UK, but could raise interest rates in 2016
The UK economy has been trundling along nicely for the last couple of years and is expected to record around 2.5% growth for this year and is seen by economists producing a similar number next year. Meanwhile, unemployment continued to fall hitting 5.2% this year and could well slip below that level next year, potentially igniting long dormant wage pressures though high inward migration should act as a damper.
Traditionally, the UK has tended to follow the US interest rate cycle with around a six-month delay. But during H2 2015, the UK has been in and out of deflation and GBP has been relatively robust, particularly versus the EUR, all of which have sapped the Bank of England’s enthusiasm for raising interest rates.
One factor to watch is that UK growth, which is very much consumer driven, has to an extent come on the back of a falling savings ratio, which is now just above 4% from its recent peak of just over 8% around 2009 – a trend that obviously can only last so long.
However, commodity prices could bottom out in 2015, as many raw materials are at prices, which are below the cost of production for many important producers. This should help relieve some of the deflationary pressures on many developed economies, such as the UK, providing less of an incentive for ultra-lax monetary policies.
Another factor to watch for the UK is politics and its renegotiation over its membership of the EU with a national referendum over whether to stay in the union to be held before the end of 2017. Whether held next year or not, the run up to it will be fraught with tension and uncertainty, which could take its toll on GBP, particularly once a date is set and the real heated debates begin.
Another factor is that the ruling Conservative party remains deeply fractured over Europe and the politics surrounding the referendum could see the party indulge in a ‘civil war’ that could rip it apart, which would also weigh on GBP.
Likely trading range for GBP/USD: 1.4700-1.5700.
Japan to continue pulling out the stops to spur growth
Abenomics was supposed to reignite Japanese vigor, slay deflation and be a new formula for economic growth. Since 2013, Japan has pursued truly aggressive stimulus policies with a huge flagship quantitative and qualitative easing (QQE) programme, has trashed JPY and boosted government spending – thought it did raise the sales tax in 2014 from 5% to 8%.
Though inflation has perked up from time to time and there has been some economic growth – all this effort appears to have produced only modest results, not counting the big rally in Japanese stocks in recent years.
GDP growth for the fiscal 2016 (starting April) is projected at around 1.4-1.7%, compared with a likely 1.5% for this year. Next year it may get a boost from an expected consumption burst ahead of another planned rise in the sales tax from 8% to 10% in April 2017 (it was originally supposed to happen in October 2015). However, once the tax level is raised, consumption tends to drop off.
Currently, companies are being pressured by the government to raise workers’ wages to help lift consumption – a move that has been resisted by smaller companies, many of which are struggling to survive in a low growth deflationary environment.
H1 2016, could also see the Bank of Japan step up QQE in a bid to reach its illusive 2% inflation target. However, if prices of leading commodities bottom out and the economy chugs along slowly there could be less deflationary pressure for the BoJ to attack.
The problem for Japan is that its monetary and fiscal stimulus plans continually bump up against the country’s increasingly lousy demographics, which are slowly strangling domestic consumption. As the years roll on the situation will continue to deteriorate.
And then there’s the Trans Pacific Partnership agreement, a trade pact, which Japan has signed up to. Among the pledges by members is to share insights into each other’s monetary policy and to not engage in competitive currency devaluations. Indeed, Japan’s aggressive devaluation of JPY has unleashed strident criticism from other Asian countries and resulted in other central banks in the region pursuing similar tactics so their country’s exports remain competitive.
At this early stage it is unclear just how much impact this agreement will have on member monetary policies and the markets won’t really know until its resolve is put to the test. The TPP is nonetheless a potentially interesting development for forex traders to watch.
Likely trading range for USD/JPY: 110-130